Sometimes it can be hard for clients to get an idea of their financial situation unless they can see a clear visual that demonstrates where their money is going. A strong visual can help people understand abstract concepts and gain a better grasp on what’s really happening.
That’s where Tax Freedom Day enters the conversation. The tax filing deadline for 2022 is Monday, April 18, but that also happens to be Tax Freedom Day for a lot of people.1 What is Tax Freedom Day, and what should advisors know about it to help guide clients through their individual financial waters? We’ve broken it down for you here.
Let Freedom Ring: What is Tax Freedom Day?
Tax Freedom Day isn’t a day in the year where people don’t have to pay taxes, as appealing as that may sound! Instead, it’s a way to visualize how much a person pays in taxes each year.
Rather than a literal 24-hour period of going tax-free, Tax Freedom Day is a day in a hypothetical calendar where a person has earned enough money to cover their tax liability for the year and, in a sense, stops paying taxes after meeting their tax obligations, and finally starts earning for their non-tax spending.2
That hypothetical calendar begins on January 1 and assumes a person is working full time and isn’t spending a single dollar of that money on anything but taxes. Thus, Tax Freedom Day becomes the hypothetical day in this calendar on which they’re “freed” from paying those taxes for the rest of the year.
This calendar calculates every penny earned going toward paying every tax that is owed for a given year — income taxes, property taxes, Social Security, Medicare, and any other tax that is owed to the federal and state governments.2
This theoretical calendar year generally figures that you spend January paying off all income taxes that would be owed for the year. Then in February, it’s time to start with the state taxes. And so it continues, until you’ve paid everything you’ll owe in the year. The exact date of Tax Freedom Day can fluctuate year to year, but for most people, it typically occurs in the middle of April.2
How is Tax Freedom Day Determined?
The date on which Tax Freedom Day falls on this theoretical calendar depends on a few factors:2
- What everyone paid out in taxes the year before
- Total personal income earned by United States residents that year
- Historical trends and recent economic data
The amount paid in taxes is divided by the total income to find a percentage ratio. That ratio is then multiplied by 365 to get the amount of days into the year it would take to finish paying all taxes.2
An individual’s own personal Tax Freedom Day may differ from the national day depending on which state they reside in, certain deductions that may apply, and other contributing factors on an individual level.
For a person to estimate their own Tax Freedom Day, they can total their federal and state tax payments from the previous year and divide that number by their adjusted gross income for the same year to see the percentage. Then, multiply that percentage by 365 to reach the total number of days into the year, beginning with January 1, that it will take before all taxes are paid.2
How Can Tax Freedom Day be Used as an Advising Tool?
The subject of Tax Freedom Day is a great entrance to a discussion about taxes in general and what your clients need to be aware of when it comes to paying their share.
With taxes in the real world taken out of every paycheck throughout the year, it may not be as easy to see just how much of a person’s earnings is used for taxes — until the following year when it’s time to file a return. By using the previous year’s data to find their own Tax Freedom Day, clients can get a better handle on how much of a tax burden they’ll have.
This is also a chance to discuss the many financial — and life — decisions that can revolve around paying taxes. For instance, people may find it tempting to live in a state that has no individual income tax, but that state may have other taxes that could affect your clients.
To offset the lack of income tax revenue, a state may have higher sales, gas, property or even candy taxes. Plus, not having a state income tax doesn’t mean that a city, county or other municipality may not have their own tax structure based on where someone lives, works, shops or all of the above.
It’s also important to examine current and expected income levels. Where a client lives now may not be where they live in retirement. Where will their money come from now and in retirement? There could be differences depending on the states. One may provide a reduced level of taxation for retirement income, while another may offer reduced taxation on investment income.
Taxes after death are another thing to keep in mind. Is your client in a state that has an estate or inheritance tax? Do they know the difference? (An estate tax is a liability of the estate and is based on the full value of the estate, while an inheritance tax is the liability of the beneficiary and is based on their portion of the inheritance.) Some states, like Maryland, have both.3
Of course, when it’s time for a client to retire, taxes shouldn’t be the only determining factor for where to spend that retirement. School systems, road repair, libraries and other governmental services are important in evaluating potential for quality of life during retirement.
Guiding Your Clients with the Right Resources
Tax Freedom Day is another useful item in an advisor’s toolbox to give clients more perspective on their finances for better planning — not just for the year but for the longer term as well. This is a chance to step away from vague estimates and use more accurate data to help manage client expectations.
If you need more information and tools, be sure to visit our Elevate™ Advanced Planning Resources, available to CUNA Mutual Group appointed advisors. The Elevate library of resources can help build your business and guide clients through complex advanced planning strategies. Click the link below to learn more.
Written by: Marshall Heitzman, CFP®, ChFC, FLMI, CPCU, BFA™
Marshall is TruStage's Advanced Planning Expert and has more than 25 years of experience in the insurance and financial services industry. He consults Financial Professionals on advanced retirement planning concepts for retirement and wealth management clients.