Advisors are being asked to do more and more tax planning, according to Robert Keebler, a partner at tax advisory firm Keebler & Associates.
Taxes are the biggest drag on investment performance, he said on a webinar for Retirement Experts Network, and he outlined how advisors can help their retiree clients manage tax burdens.
CPAs are dropping out of the business as technology has made it easier for non-certified professionals to do more tax work, he said.
“Your job as a financial advisor on the tax side is how to create tax alpha,” he said, so clients can maximize their income in the decumulation phase.
“It’s nearly impossible to create wealth in the United States today when your interest, your capital gains and your dividends are taxed as quickly as you earn them,” Keebler said.
Gain and Loss Harvesting
The “easy strategies,” Keebler said, that advisors need to get their heads around include capital gain harvesting – not capital losses – which recognizes there’s a “zero percent bracket for capital gains purposes when I’m in the 15% bracket for regular tax.”
Capital gain harvesting is shifting recognition of capital gains from a higher bracket a client might face in a future year, into his or her current bracket.
“If you get to December and you have a client who’s still in the 15% bracket, there’s no reason they wouldn’t want to harvest gains at the top of that 15% bracket because they’re not going to pay a penny to do that,” Keebler said. “If you expect to be in a higher bracket in the future, you sell capital gains this year; there’s no wash-gain rule. You can immediately turn around and buy these back.”
Keebler added that long-term gains are taxed at 15% or 20%, while short-term loss might give clients a 39.6% benefit in the future, so “you never want to use short-term losses to offset long-term gains.”
The reverse – using long-term losses to offset short-term gains that clients must take or have already taken – can be “extremely powerful” because the long-term gains are “virtually worthless at 15% or 20%
Timing capital losses and income smoothing are also important, he said.
Roth conversions, net unrealized appreciation opportunities, annuities, life insurance and retirement plan contributions are all areas tax-minded advisors need to familiarize themselves with, Keebler said.
- Roth conversions: Since 2010, conversions are not limited to clients with $100,000 in income.
- Net unrealized appreciation: A client can pull company stock out of his or her plan and only pay tax on the cost basis, Keebler said, and advisors need to have a “conscious competency” of NUA when taking funds from pension plans in particular.
- Annuities: Annuities are “naturally very complicated,” Keebler said.
- Life insurance: Life insurance is “nothing more than a statutory tax shelter,” Keebler said.
- Retirement contributions: Roth IRAs and Roth 401(k)s are valuable tools, especially in clients’ early years when they’re in the 15% or 25% tax bracket, he said.
Short-term gains are taxed at ordinary rates, and long-term rates are taxed at lower rates.
Advisors have to look at assets’ allocations and locations, as well as tax incentives, to help their clients build tax-efficient portfolios, Keebler said. Once advisors figure out how a client’s assets should be allocated, they need to determine where they should be located. “Where do we want the growth stocks? Where do we want the blue chip stocks?” he said. “How do we get the best tax advantage of repositioning these?”
There’s a “sincere” and “well-reasoned” argument for investing in passive investments rather than active from a tax perspective, Keebler said. “If your portfolio manager can’t generate a substantial return above the S&P 500, you’re better to be passive,” he said.
Retirement investment accounts may be taxable; tax deferred, like traditional IRAs and 401(k)s; or tax free, like Roth IRAs and life insurance plans, according to Keebler. Those distinctions are especially important for younger workers who are deciding how to position their wealth.
In a Roth IRA or a life insurance contract, basis is taxed first, then earnings. With a non-qualified annuity or a modified endowment life insurance contact, earnings are taxed first, then basis, Keebler said.
“If you can keep somebody in the 15% bracket, that means they’re going to be in the 0% capital gain bracket,” he added.
A checklist of tax-sensitive withdrawal strategies would include:
- Manage Social Security benefits taxation
- Manage income tax brackets
- Select high-basis securities to sell first
- Aggressively harvest outside portfolio losses
- Defer Roth IRA distributions
- Begin Roth conversions if practical
- Implement tax-efficient annuity strategies
- Manage charitable gifts
- 3.8% Medicare “surtax”
Keebler had these recommendations for advisors trying to build tax-efficient withdrawal strategies.
- Fill up the 10% or 15% bracket.
- Plan Roth conversions by asset class and to manage tax brackets, and follow conversions with recharacterizations.
- After the 15% bracket is filled, spend from the outside portfolio first.
- Bonds should generally be held in an IRA due to the annual tax burden.
- Life insurance is “an extremely, extremely valuable supplement to existing pensions.” In a trust, it may also be a substitute for bond portfolio because bonds “will get hit with tax every year and the life insurance will not.”
For investors between 25 and 45, advisors should be focusing on getting retirement savings started, maximizing IRAs and positioning some funding for Roth accounts, review their whole and universal life insurance needs; and investigate low-risk real estate strategies. Advisors should continue those strategies for investors between age 46 and the beginning of their retirement, but they should also aggressively manage taxation on their wage earnings and their investments.
Retirement Age and Beyond
At clients’ retirement, advisors should shift to evaluating rollovers of their pensions and profit sharing plans; managing NUA opportunities; monitor the 10% tax penalty on early distributions; manage basis in IRAs and qualified plans; manage qualified Roth distributions; and evaluating asset protection issues. It may be prudent to contact a client’s attorney if there are concerns about moving pension assets, he recommended.
“When money is in an ERISA plan, it is protected. Always remember, if you doubt that, that O.J. Simpson continues to receive his NFL pension, notwithstanding tremendous judgements against” him, Keebler said.
In the early retirement years, Keebler recommended advisors look at how to use basis to keep clients in a lower tax bracket; defer IRA distributions that are taxed at 25% or higher, and which accounts they should draw from first. Roth conversions might be another consideration.
“We will never understand until we walk across that bridge what it’s like to know that you’ve left your job and there’s no more money coming in,” Keebler said. Most people, if they stopped working today, could go back to work as soon as they decided to and “doors would swing wide open.” Some people, like airline pilots, have mandatory retirement ages and don’t have that luxury.
“When you get those narrow skill sets and there’s no more money coming in, we have to get retirement right,” Keebler said. “If we can make it last a little bit longer by doing things like this, that makes all the sense in the world.”
— Read The Post-70 ½ Retirement Plan Contribution Rules on ThinkAdvisor.