More On Tax Planningfrom The Advisor's Professional Library
- IRAs: Eligibility The eligibility rules for contributing to traditional and Roth IRAs are complicated. Learn how to effectively use them in retirement plans.
- Annuities: Estate Tax The value of certain types of annuities may be included in an estate’s value. Understanding the intricacies of these inclusions is a critically important aspect of estate planning.
With the S&P 500 finishing about where it started, 2011 was a tough year in the market and it won’t be the last, especially if the consensus forecasts come true for 2012 being a year of continued slow economic growth and volatile markets.
Years like these can make it difficult for financial advisors who focus only on investment returns. It’s true that advisors still provide a lot of value, especially in helping clients stick to their asset allocations through all the ups and downs of the markets, but clients don’t always view things that way. They want to see that their advisors are consistently providing value on a range of issues.
One opportunity to provide that value and differentiate yourself from the competition is with a topic on many Americans’ minds this time of year: taxes. As W-2s and 1099s hit their mailboxes, they’ll be hearing many promises from the presidential candidates about their plans to reduce taxes. But let’s be realistic. Given all the gridlock in Washington and the growing budget deficits and shortfalls in Social Security and Medicare, how many of us really believe that taxes will continue to go down from their already historic lows?
While the politicians may not be able to do much, financial advisors are in a great position to deliver a tangible tax cut their clients can believe in. Consider these eight ways to help your clients trim their tax burden:
Reminder #1: Retirement plan contribution limits are increasing this year.
Many people who think they’re maxing out their retirement plan contributions are using limits from five or even 10 years ago. That’s because while people will often look at their investment allocation, they may not revisit their contribution election, especially if they think they’re already maxed out. Remind your clients that they can now contribute up to $17,000 per year (or $22,500 for those 50 or older) to retirement accounts like 401(k)s, 403(b)s, and the federal government’s TSP. That extra $500 a year of course would grow to almost $25k in 20 years at an 8% average annual return. The additional savings may not be hugely significant but it could mean your clients get some extra cash to kick off retirement with a nice vacation.
Reminder #2: HSA limits are going up.
Retirement plans aren’t the only ones with higher contribution limits. Health savings accounts are getting in on the fun as well. If you have clients with high deductible health insurance policies, make sure they’re taking full advantage of the unique benefits of these accounts. I don’t know any other accounts in which you can make both pre-tax contributions and tax-free withdrawals. The contributions can even escape FICA taxation if they’re part of a Section 125 cafeteria plan.
Reminder #3: More people are eligible for 2012 IRA contributions.
While the IRA contribution limits aren’t increasing, the income limits to contribute to a deductible or a Roth IRA are. That means you may have clients who can now take advantage of these accounts for an immediate tax break or tax-free income in the future. Either way, it’s more money in their pocket.
Reminder #4: Clients can still undo last year’s Roth conversions.
With all the volatility in the markets last year, you may have some clients who paid taxes to convert some traditional IRAs to Roths only to see their account values plummet afterwards. Remind them that they have until Oct 15th to re-characterize those conversions, which is basically a fancy way of asking for a do-over. This allows them to avoid paying taxes on money they no longer have. The only downside is that they have to wait until next year if they want to do a re-conversion back to a Roth IRA.
Reminder #5: Consider Roth conversions.
On the other hand, you may also have clients with traditional IRAs that are down in value (especially if the Mayan calendar ends up being right about 2012!). In that case, it could be a great time to convert those IRAs to Roths. First, they’ll pay relatively low tax rates (remember, tax rates are still scheduled to increase next year) on relatively low account values. Then, when the account eventually recovers, all that growth can potentially dodge whatever tax rates the federal government has in store for us at that time (when millions of Baby Boomers become eligible for Social Security and Medicare). In fact, Roth IRAs can be a good idea for any client worried about the prospect of higher future tax rates.
Reminder #6: Look out for company stock before rolling over retirement assets.
Speaking of 401(k) rollovers, advisers will sometimes roll over entire accounts as cash without even looking at what’s in them. If your clients have company stock, they would lose the ability to have the net unrealized appreciation taxed at a lower capital gains rate.
Reminder #7: Tax optimize your clients’ investment portfolios.
If something needs to be exposed to taxation, let it be your clients’ equities since most of their earnings are taxed at capital gains and dividend rates that are lower than the ordinary income tax rates at which the pre-tax withdrawals will be taxed. (This is especially true for international equities because your clients also lose the ability to claim the foreign tax credit if they’re sheltered in a retirement account.) Having stocks vs. bonds in a $500,000 taxable account with a 2% interest or dividend yield could be a difference of several thousand dollars for your clients.
Reminder #8: Harvest those losses.
Another advantage of having more of the equities in the taxable account(s) is that it provides you the opportunity for tax-loss selling at the end of the year. This is a great way to turn those investment lemons into tax lemonade.
Don’t let the reminders end there. At the end of the day, be sure to track how much you’re saving clients so you can truly show them the value of your services.
As financial educators at Financial Finesse, we deal with employees whose net worth is much less than those most advisors work with, but when we’ve tracked this ourselves, we’ve managed to account for helping employees save tens of thousands of dollars in taxes.
In this economy, reminding clients that you can help them with a broad scope of financial issues that affect every part of their lives can be what sets you apart. It feels pretty good, too.