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.