High-income clients may ask you about taking voluntary withdrawals from IRAs to fund Roth IRAs. This strategy is unwise and unnecessarily expensive because of the taxes they’ll pay. Roth conversions make sense as members of a household transition into retirement, their wages disappear, and they aren’t yet eligible for their full Social Security benefits.
You can help clients reduce their investment taxes in four ways, by:
1. Holding in their IRAs highly taxed assets, like high-yield bonds and high-turnover stocks that realize a lot of short- and long-term gains.
2. Substituting (especially in-state) municipal bonds for taxable bonds.
3. Delaying realization of gains on stocks for a long time.
4. Harvesting losses on stocks.
Many clients will be surprised they can reduce their investment taxes using their IRAs, even though investment income and gains are not taxed in them. While clients will have invested in municipal bonds, they are likely to underestimate their tax rates on interest income, especially if they have high earned income.
It takes discipline and understanding that retirement almost always means a drop in income for clients to accept they should delay realizing gains on stocks. Even when well-prepared for retirement, many clients find Social Security, pension, and annuity income only partially replace what they earned in wages. My father held onto Berkshire Hathaway stock for decades, and its cost basis stepped up at his death.
Harvesting tax losses are table stakes for investment advisors. However, many clients have few tax losses after years of a bull market. Advisors who delay gains for their clients build up an inventory of unrealized gains in portfolios, leaving almost no capacity for realizing losses.
Help Your Clients Who Lost Jobs Or Income Due To The Pandemic
The upheaval of the Covid-19 pandemic led to many early and unplanned retirements. If you have clients in this situation, they need your advice—urgently.
First, they need to responsibly withdraw from their retirement accounts. Premature retirement usually means a loss of 5% of spending from account withdrawals for each year of lost wages. And clients should not give in to temptation to file for Social Security early, before age 70, when they are eligible for the maximum payout.
My father was always concerned about the effects of the economy on employment and retirement income. He served many years on the board of TIAA-CREF in consideration of his colleagues’ retirement security. He didn’t, though, walk in your shoes and need to advise individuals on how much they can afford to spend and withdraw from their retirement accounts.
Advisors who address their clients’ needs with empathy, knowledge and foresight, will win their clients’ trust. Incidentally, advisors who help clients understand the intricate levers of retirement saving and spending also stand a better chance of clients choosing them for management of all their households’ accounts.
Paul Samuelson is chief investment officer and co-founder of LifeYield.