As 2019 winds to a close, it’s important for advisors to take a closer look at where clients are likely to end the year from a tax perspective. While this time of year can be a busy one for advisors and clients alike, it’s important to evaluate now. You won’t be able to take advantage of these opportunities after Dec. 31.
1. Harvesting Capital Losses
Hopefully, at least once a year, you are running unrealized gain and loss reports for your clients to determine whether there are positions that can be sold at a loss and replaced with appropriate holdings to capture the loss for tax purposes. Each dollar of capital loss often represents a 15% tax savings as most people fall into a 15% capital gains bracket. For some, it may represent an 18.8%, 20%, 23.8%, or more depending on the interactions with the net investment income tax and other income streams.
2. Harvesting Capital Gains
You’re probably running reports from custodians or different insurance companies to make sure the required minimum distributions have been taken. Most likely you also are running realized gain and loss reports, since harvesting capital losses for most clients is going to be an annual consideration.
However, harvesting capital gains can be a good option for some clients who fall in the 0% capital gains bracket, resulting in a free step up in basis. This situation is often present for those who are between early retirement and age 70 1/2. Sometimes it can make sense to harvest capital gains up to around $100,000 if you can keep all the other ordinary income off the table.
3. Minding Pass-Through Gains (Phantom Capital Gains)
Around this time of year, mutual fund companies start to publish estimates of capital gains that have been realized in their funds and will need to be passed through to then-current shareholders. Along with the estimated percentage of capital gains, the companies generally also will post a date of record. If you hold the fund as of that date, you will receive a 1099 representing your pro-rata share of the gains recognized inside the funds.
Advisors should consider whether the phantom capital gain is greater than the gain that would be recognized if the position were sold. If the phantom capital gain is greater, then you have the opportunity to sell and reinvest into a more tax-efficient vehicle. Exchange-traded funds and some tax-efficient mutual funds may be options. If the client’s situation warrants, tax-deferred vehicles, such as annuities or life insurance, also could be considered.
4. Roth Conversions
In other circumstances you might be looking for Roth conversions. Sometimes those Roth conversions actually can be free. You can take that Roth conversion up to the beginning of the 10% tax bracket and occasionally you might not have any other ordinary income. So, getting $10,000 or $15,000 out of an IRA with zero tax bill is a real opportunity. In other circumstances you might be able to convert right up to the point where you start to get the Social Security tax torpedo or maybe just to the edge of a Medicare premium threshold.
The Hidden Value
Doing all the above will add enormous value to your clients, but presenting these opportunities also can help you grow your financial planning practice. You can do this by effectively communicating the value that this tax-efficient retirement advice adds. Clearly show your clients your value as an advisor by taking advantage of these opportunities to add dollars to their retirement plans.
Joe Elsasser, CFP, RHU, REBC, founded Covisum, a financial tech company focused on creating a shared vision throughout the financial planning process. He developed his Social Security Timing software in 2010 because, as a practicing advisor, he couldn’t find a Social Security tool that would help his clients make the best decision about when to elect their benefits.