If you aren’t mapping this out, you won’t be able to have a fruitful conversation with your client or the client’s CPA about the tax cost of taking large capital gains—or when you should take them. Or consider your business owner clients who may be selling their companies soon.

Recognizing capital gains on their investments the year before their sale could be optimal. Yet if a business transaction is structured as a multiyear installment sale, this could mean your clients will find themselves in the top tax bracket (and subject to the 3.8% surtax) for a number of years. You and your clients need to plan for their tax bill accordingly. After all, the more our clients pay in taxes, the less of their portfolio they keep.

Diversify Clients’ Savings Buckets
When news of the 3.8% surtax first hit the media, it seemed advertisements for tax-deferred annuities were everywhere, encouraging clients to save their money each year in a vehicle that is not subject to the 3.8% surtax. Cramming every dollar into such a vehicle could feel good while clients are building wealth, but it could hurt them when it comes time for them to live off their portfolio.

Recall that the 3.8% surtax thresholds are based on AGI, so when clients start withdrawing money from their tax-deferred accounts during retirement, that recognized income could raise their AGI above the applicable thresholds. This will cause them to be subject to the 3.8% tax on certain portfolio income. Clients don’t want to be paying more in taxes during retirement when their resources are limited!

Diversifying clients’ savings buckets is wise to help them save taxes today, but give the clients (and yourself) more flexibility when they retire to figure out where their retirement income will come from and how much of their retirement portfolio income will be subject to income taxes and the 3.8% surtax. During their working years, their savings strategies should include maximizing the funding of their pretax 401(k) plans. They should also take advantage of pretax non-qualified deferred compensation savings, do annual Roth IRA conversions, fund tax-free health savings accounts, build a taxable portfolio and consider annuities or cash value life insurance products. Then, in retirement, your clients will have buckets subject to different tax consequences—ordinary income buckets, capital gains buckets and tax-free buckets—to draw from. Different tax buckets maximize flexibility each year to help you determine which accounts to take withdrawals from, and they can help retirees keep their year-to-year tax bill manageable.

The Affordable Care Act impacts many areas of a client’s comprehensive wealth management plan. Take action to understand the impact for each of your clients, and then update their insurance, investment and cash-flow strategies if appropriate. This will serve you and your clients well, and expand your capabilities and resources as their trusted advisor. 

Lisa Brown, CFP, CIMA, is a wealth advisor and partner at Brightworth (brightworth.com), an Atlanta-based, nationally recognized independent, fee-only private wealth counsel firm that serves high-net-worth families and individuals.
 

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