I was recently referred a couple hoping to retire this year. Their current financial advisor recommended investing $265,000 into an annuity, and the couple wanted a second opinion.

When I talked to them on the telephone, I asked them to bring certain items to the meeting, including a copy of their tax return and a list of questions. The very first question they asked me was whether I felt this annuity was a good investment. I replied that I wouldn’t be able to answer that question until I had a better understanding of their goals, objectives, and risk tolerance.

During our meeting, the couple provided me with a 25-page financial planning report from their financial advisor, along with a five-page sheet that the advisor had them fill out. The couple didn’t understand anything in the report and, quite frankly, the color graphs were the only interesting items in this printout.

While some advisors prepare reports and charts and have the client fill out forms, I instead read the tax return, which tells me about 95 percent of what I need to know about my clients.

So how can you use tax returns to generate sales prospects and learn more about your potential clients? Here’s a case study based on that same couple who called me for advice.

In this case, I looked at exhibit 1 on the 1040 tax form — wages, line 7 — and saw the number was $230,000.

Me: I see your wages for the year were $230,000. Do you currently have a retirement plan at work? If so, do you still contribute to the plan?
Clients: Yes; we have a retirement plan, and we each contribute 6 percent of our salary.

Me: Before you retire from the company, we should talk with your human resources department. I want to make sure all your benefits are coordinated correctly, such as 401(k) plan (rollover), and life insurance benefits.

Next, I look at Form 1040, line 8a. Taxable interest is $319 – and according to Schedule B, part I, ABC bank nets $174 and XYZ bank $145.

Me: How much interest do you earn in ABC and XYZ bank?
Clients: Both are six-month CDs, earning about 3 percent interest.

So now I know the clients have approximately $10,000 in cash ($319.00/.03).

Me: How much are your monthly expenses?
Clients: $5,000-$6,000 a month.

Therefore, I know these clients have approximately two months of an emergency fund available in case they lose their jobs or run into any unforeseen expenses. I would tell the clients that they should have at least six to nine months of liquid cash, and as such, they need to increase what they already have.

Me: Any credit card debt?
Clients: $12,000 in credit card debt at a rate of 14 percent interest.

Now, I look at Schedule D, where most sales of stocks, bonds, and mutual funds are reported. Here, I see that the client bought XYZ managed money account on Aug. 4, 2008, and sold the investment on Dec. 31, 2008 for $265,474. The clients paid $413,124 for the investments and have a short term loss of $147,650.

Me: You only owned XYZ managed money account for only five months. What was the reason for selling?
Clients: We are scared of the stock market and can’t handle the volatility.

Now I know that the annuity recommended by the other advisor could be a sound investment for the clients. In addition, Schedule D alone could lead to 10 to 15 sales ideas based on the issues the clients are having and their current situation.

In reviewing just a couple of items on the tax return we know the following:

  • The wife is 57 and the husband is 60 years old, and they both want to retire.
  • The couple has retirement plans at work.
  • They lost $147,650 in the stock market in five months.
  • They are scared of the stock market.
  • They do not like volatility.
  • They only have two month of liquid cash.
  • They have $12,000 in credit card debt at a rate of 14 percent.
  • Their monthly expenses are $5,000 to $6,000 a month.

The big question is, should they invest $265,000 into this annuity? Despite the fact that it could be suitable for a couple in a similar situation to theirs, the answer in this case is no, they should not buy this annuity.

Looking back at Schedule D at the investment sales price of $265,474, we see that the advisor is investing all the client’s money into this annuity without taking into consideration any of the following issues:

  • The clients’ cash position of only $10,000 — they need another $20,000 to $30,000 of liquid assets just to cover their monthly expenses.
  • The $12,000 credit card debt at 14 percent interest — they should focus first on paying off their debt.

In the end, we were able to determine the suitability of this recommendation for this particular couple — all by looking at their tax return. Tax returns, then, can be a valuable source of information that can not only allow you to make valuable recommendations, but also to learn more about your prospects in order to generate future ideas for products, services, and other sales.

Brian Gilder is a CLU and CFP. He can be reached at brian@followthetaxreturn.com.