Advisor Perspectives welcomes guest contributions. The views presented here do not necessarily represent those of Advisor Perspectives
This article is the fifth in a series of the seven most-common mistakes financial advisors make on tax planning with clients
When it comes to financial advisors and tax strategies, they often sound like old fishermen telling the story of “the one that got away,” except the stories are about ultra-obscure tax strategies that they have never used. This tendency to tell stories about the tax strategies that got away is so prolific that anytime an advisor approaches me about a tax scenario, I immediately ask for the name of the client to ensure we are talking about real life versus tax fantasyland.
All this excitement around exotic tax strategies often causes advisors to make the mistake of ignoring the basics in hopes they will finally, someday have a chance to implement an intentionally defective grantor trust using multiple discounted family LLCs, while claiming residency in Puerto Rico and owning all their assets inside of a private placement life insurance policy that is placed inside a spousal lifetime access trust (SLAT).
For the 99% of advisors and their clients who will never need such planning, I want to draw your focus to the three most important, yet boring, tax strategies that every advisor should be discussing with every client. Warning: I know you already know these, but before you click to the next article, remember that you also know how to get six-pack abs and earn a billion dollars. In other words, this isn’t about what you know; only what you do counts.
- Evaluating Roth conversions for every client, every year
Yes, I know that Roth conversions have been around for the better part of 30 years and you’ve attended a dozen or more sessions on them. But are you running the calculation for every client, every year and letting them know that you’ve done it? Except for clients who are in their peak earning years, nearly every client can benefit from using the remainder of their marginal tax rate for Roth conversions so that someday when they need a lump sum of money, it can be withdrawn tax free. This discussion with clients, which should be done annually, can be as simple as this: “Mr. & Mrs. Client, would you rather pay the IRS $10,000 in taxes now, or $20,000 in taxes later?” The math on this question? If they did a $50,000 Roth conversion now at 20%, the tax would be $10,000. If they waited X number of years until the IRA doubled to $100,000 and then pulled the money out at 20%, the tax would be $20,000. Does this perfectly account for the time value of money? Of course not, but I challenge you to find a client who can articulate time value of money.
- Leveraging charitable giving
Before the standard deduction was increased to $25,900 (married filing jointly in 2022), it was easy to spot a client’s charitable contributions on their tax return. Now with the increased limit, the majority of clients do not itemize, which means you have no choice but to ask if they are supporting charities. “Mr & Mrs. Client, the IRS used to make it easy to get a small tax benefit when you give money to charities. Today it requires a bit more work, but great news, we are pros at it. Are there any organizations you currently support or would like to support?” If the answer is “no,” great news, the client has still been made aware of your tax expertise. If the answer is “yes,” you can get more details about how much they contribute. Even for clients contributing only a few hundred or a few thousand each year, strategies such as donor-advised funds, front-loading contributions and/or qualified charitable distributions can have an impact. While the actual dollars saved may be objectively immaterial, the psychological impact of saving money in taxes creates incredible goodwill between you and your client.
- Explaining taxes in buckets
You and I can throw around terms like Roth, IRA, pre-tax, non-qualified and/or tax-free all day, but for clients, this is total Greek. Instead, use this simple illustration (or something similar) to help clients understand the tax implications of each “bucket” of money. Start with a glass of water, not the firehouse. Have a high-level conversation explaining the different ways income can be taxed, so that you are building a foundation you can refer back to in all future tax planning conversations.
To tax experts like you and me, these three strategies will seem too basic to warrant your attention, but when it comes to taxes, it’s less about the actual dollar amount being saved, but about the emotional benefit to clients of knowing that finally someone is helping them avoid overpaying the IRS.
Pick one or two of the most common tax strategies for your niche (e.g., Roth conversion) and create a system for talking to every client about it every year. This can be as simple as a casual mention during a meeting or email, or as complex as an entire meeting dedicated to this strategy. Either way, you need the client to know that you are being proactive on taxes. Whichever strategies you implement, have follow up reminders in your CRM to make sure they are taken to completion. For example, if you are doing QCDs, you need a reminder in Q1 to make sure their tax preparer reports the donation correctly on the tax return. When talking with tax pros (real or self-proclaimed), ask to see the actual scenarios where their strategy was implemented. Last, make sure that as you recommend strategies you are avoiding mistake #2, which is cutting off your chances of getting referrals from tax preparers.
Come back next week for part six in this seven-week series. Until next time, happy tax planning!
Steven A. Jarvis, CPA, MBA, is CEO and head CPA of Retirement Tax Services.