What Determines which Strategy is Starred in the Tax Lab?

The Green Star (☆) tag on the Strategies list in the Tax Lab is placed next to the strategy that is estimated to have, over the life of the plan, the...

1. Highest total net income
2. Highest net legacy
3. Lowest total taxes
4. Lowest average effective tax rate

The ranking is run in the order above. For example, #1 is equal across all strategies, so we move on to #2, and so on. By default, this strategy is set as 'Strategy 1' in the Tax Lab's Compare section, with 'Strategy 2' set as 'Taxable, Tax-Deferred, Tax-Free.'

These projections are, of course, not the only things you will consider in developing a plan for a client. For example, you'll also want to consider the projected break-even point for these strategies (that is, when the cumulative estimated taxes paid for one strategy go lower than those of the other strategy). If it takes 28 years for Strategy A to be lower than Strategy B in cumulative taxes, this is clearly less attractive than if that point is found eight years in.

Furthermore, just because a strategy has lower estimated long-term taxes does not mean that it is the right strategy for a household. There may be particular reasons to choose a different strategy, including an aversion to paying a large tax bill in any given year. You can always change the strategies you are comparing or exploring by using the dropdown menus.

You can also limit, for this plan, the total inflation-adjusted dollar amount of Roth conversions in any one year by clicking the Advanced Settings option in the upper 'three dots' menu:

Then go to the Taxes section.

Finally, click the box next to 'Enforce annual dollar cap on Roth conversions. ' Enter the amount you choose in the box below, click 'Save, ' and return to the plan. All Bracket Management strategies for this plan that you evaluate in the Tax Lab will now limit Roth conversions to this cap, adjusted for inflation. Note that you can set a Roth cap even if the plan itself is not set to use a Bracket Management strategy (one that includes Roth conversions). The Roth cap will apply when you are evaluating Bracket Management strategies in the Tax Lab.

Note that there can sometimes be a trade-off between the possible tax benefits of Roth conversion strategies (those found in the Bracket Management strategies in the Tax Lab) and other aspects of the plan. A plan that front-loads portfolio withdrawals will often have a somewhat higher risk than a plan that does not do so. That's because the sequence of returns risk is higher when portfolio withdrawals are front-loaded. Roth conversions can increase the portfolio withdrawals for a plan in order to pay taxes. (A similar trade-off is often found in the decision to take or delay Social Security.)

All of these considerations and more make long-term tax estimates just one of many factors that advisors and clients take into account when deciding on a plan to follow.