News of the shifts in income tax thresholds, deduction limits and 401(k) contribution limits may have stirred your clients’ interest in reviewing their tax situation before the year-end. But if they haven’t called you, call them. Now is the time to review their positions and the choices they need to make before December 31.
Don’t limit your tax evaluations to tax harvesting. There are other subjects to put on the agenda for Q4 meetings, depending on individual circumstances, including:
• Asset location and substitution
• Required minimum distributions (RMDs) and Roth conversions
• Charitable donations and deductions
• Inflation, retirement savings and income
Asset Location And Substitution Matter More Than Tax Harvesting
Persistent and high inflation, bad returns on stocks, and terrible bond returns have made 2022 an unforgettable year (in the wrong way).
Clients who own individual stocks, stock funds, bonds and bond funds can harvest tax losses from their brokerage accounts. But most of those losses will have to be carried forward. As a result, clients will not have a significant reduction in their investment income.
Tax harvesting, in my opinion, gets too much attention. Using asset location and substitution, you can save investors much more in taxes than tax harvesting. Here are some examples:
• If you replace a high turnover approach with a buy-and-hold strategy, your clients will accumulate significant unrealized gains in their brokerage accounts over time. Most of those gains will not disappear in one market downturn.
• Manage your clients’ portfolios in a tax-smart way by holding bonds with higher yields and stocks with higher turnover (and realized gains) in their individual retirement accounts (IRAs) or other tax-favored accounts.
• With significant increases in bond yields, eschewing taxable bonds for in-state municipal bonds with their generous tax treatment can save clients in taxes, particularly in states with high income-tax rates.
Required Minimum Distributions And Roth Conversions
Year-end is the deadline for older clients to take required minimum distributions (RMDs)—or pay penalties. The landscape around RMDs has changed and demands your attention.
Under the SECURE Act of 2019, beneficiaries of IRAs and similar accounts who are not spouses have 10 years to empty the accounts of assets when the owner dies. For some clients, it may be wise to take moderate voluntary IRA withdrawals to fund Roth conversions now to prevent their heirs from paying taxes on inherited IRAs.
Clients with large IRAs who won’t need their RMDs for income can make limited charitable donations from the accounts to lower their tax bills.
Before they must take RMDs, clients in early retirement often have lower non-investment income and lower rates, especially if they delay filing for Social Security. You can win their confidence—and possibly their referrals—by providing a plan for taking coordinated low-tax withdrawals from their IRAs and brokerage accounts to fund their spending needs and Roth conversions.
Charitable Donations And Deductions
This is the time of year when many nonprofits make appeals. If your clients have a philanthropic mindset, you can suggest ways for them to do good and save on taxes.
Contributing individual stocks and stock funds with significant unrealized gains to a donor-advised fund (DAF) is the most tax-efficient and convenient move for most clients. Clients avoid realizing gains and can take the tax deduction when they contribute the stocks to donor-advised funds. They can tap the fund to make charitable contributions this year or in the future.
Let your clients know, too, that the same level of charitable donations will yield more tax savings this year than next because of inflation’s effect on 2023 federal deduction limits and tax brackets.
Inflation, Retirement Savings And Income
Inflation will allow clients to make larger qualified contributions to their 401(k)s, IRAs or other tax-advantaged accounts in 2023. Higher living costs, though, may restrict clients, especially younger ones, from taking advantage. Remind them of the long-term benefits of saving and guide them toward tax-smart investing, starting with asset location, for better after-tax returns and account growth.
Clients in their 50s and 60s may be afraid that their savings won’t last their lifetimes. You can help by returning to their financial plans and seeing if they are on target for producing the income they’ll need in retirement. Some may need to work longer or save more.
High-income clients seeking options for retirement income planning may be interested in learning more about investment-only variable annuities (IOVAs). These products resemble IRAs, but they are funded with after-tax contributions.
You may want to introduce clients who are retired and interested in guaranteed income to income annuities, which have lower fees and more flexible schedules than they did in the past.
The financial advisor’s life is perpetually one of finding opportunities and advising on the next-best steps to take, whatever situation their clients are in or the mayhem in the markets.
The declines in once high-flying tech stocks, among others, may have sobered up some investors. As 2022 comes to a close, your clients and prospects may be more amenable than in the past to advice to follow the tried-and-true philosophy of buying and holding a diversified portfolio of stocks and bonds or funds.
Paul R. Samuelson is the chief investment officer and co-founder of LifeYield.