Tax Planning in 2025: Five Key Topics to Discuss With Your Clients Now

Executive summary:

The start of a new year is a good time to try something new – such as implementing or improving the tax efficiency of your clients' portfolios
Investment taxes can have a detrimental impact on an investor's after-tax wealth
Running a tax analysis on a portfolio can help show the difference in allocations, risk and return, and overall wealth
We suggest five relevant topics to bring up with clients to get them thinking about the benefits of tax managed investing

The calendar page has turned, and that means we have the opportunity to get 2025 off to a good start. Many of us make resolutions to improve our health, our relationships, careers or lifestyle. Why not also make a resolution to help your clients maximize their after-tax wealth this year?

At Russell Investments, we believe tax management is an integral part of investing. And we believe that tax management is a year-round activity. So the beginning of a new year is an ideal time to get your clients thinking about how to reduce their tax liabilities to keep more of their money in their pockets rather than Uncle Sam's.

To help you get started, here are five topics we think merit a discussion with your clients as the new year unfolds:

1. Create a realistic plan

Too often investors pin their hopes on vague promises or speculation on what might happen next, a human trait that can be fueled by what they read in the media. I worry that some investors are hoping and dreaming the ongoing tax debates mean that taxes will somehow miraculously move closer to zero. Taxes are not going to zero!

Help your clients embrace what we have today and plan accordingly. Take a look at the tax tables for income taxes and long-term capital gains below. Talk to your clients about which of the tax rates applies to them and then discuss ways to mitigate the impact of those taxes on their portfolio.

2. Prepare for potentially higher capital gains distributions

Despite the challenges and uncertainties we've faced over the past few years, U.S. financial markets have done remarkably well. This has generally meant that investors' wealth has appreciated. But while the impact of taxes on taxable portfolios has been muted recently due to relatively modest levels of taxable capital gains distributions and realizations, changes are likely.

Looking at the last eight years of market returns and capital gains distributions, investors have enjoyed a bit of a goldilocks period. With the exception of 2018 and 2022, market returns have been robust and capital gains distributions modest. Whether it's through higher volatility or a cyclical change in drivers of market returns, we believe turnover in portfolios is likely to increase. And this means taxable gain realizations will increase as well. Plan now. Think about how harvesting losses, transitioning a portfolio, and embracing tax management can help your client pursue improved after-tax wealth.

Capital gains distributions in context

Annual returns and taxable distributions

3. Don't overlook interest income

For fear of stating the obvious, if it doesn't say "Tax Exempt Interest" it's not exempt from taxes.

Interest is taxable as ordinary income. Yes, this is something that needs to be said multiple times and many different ways. Too many investors still don't understand this and are overweighted in their taxable portfolios with ordinary interest-paying investments. Whether it's total-return bond funds, high yield funds, money market accounts, and even CDs (certificates of deposit), they all have one thing in common: they pay taxable interest.

At the top federal income tax bracket of 37% plus the 3.8% Net Interest Income Tax (NIIT), interest income could be taxed at 40.8%. However, the interest income on investments that pay Tax Exempt Interest is 0.0%.

What do you think is better for your clients? A tax rate of 40.8% or 0.0%?

4. Start legacy planning early

Delaying and procrastinating on legacy planning could result in a loss of choice. Investors generally can opt to have their wealth go to the government in the form of taxes after death or have more of it go to heirs or a charity of choice.

Today's estate tax and gifting exemptions offer significant opportunities for tax-free in heritance planning. With exemptions of nearly $14 million, there is plenty of room to craft effective strategies—if you plan ahead. Some investors hold out hope for even more favorable tax laws in the future, but waiting could be a costly mistake.

What's stopping investors from acting now? Often it's overthinking. Don't let analysis paralysis delay important legacy planning. If the tax laws change, plans can be adjusted. But without a plan, an investor's estate could face unnecessary taxes, leaving their loved ones with less.

Encourage your clients to act now and secure their financial legacy.

Estate tax per person

Transfer tax rate (maximum): 40.00%
Estate tax exemption: $13,990,000
Gift tax exemption: $13,990,000
Generation-skipping transfer exemption: $13,990,000

5. Embrace tax management

The distinction between taxable and tax-deferred assets is critical for effective financial planning. Taxable assets, also known as non-qualified accounts, are subject to taxes on income and distributions in the year they are earned. In contrast, tax-deferred assets, or qualified accounts, allow investors to delay taxes until a future date, typically when they are no longer working and withdrawing from their portfolios. Most investors hold a combination of these types of accounts, making it important to understand how each impacts the overall tax strategy and financial goals.

It may seem straightforward--and even common knowledge--but many investors manage their taxable and tax-deferred accounts in the same way (i.e. IRAs, 401Ks, 403Bs, etc.). This is understandable: when a strategy works in one type of account, it's natural to assume it will work in another. Unfortunately, taxable accounts have an additional investment parameter that comes as a sizable cost for investors. That cost is taxes, and the impact can be large.

How large? That depends on an investor's time horizon. For example, a $500,000 taxable account could face an annual tax cost of about $10,000, based on a 2% tax drag (the long-term average). But as time goes on and as assets grow, so does the annual tax bill. Worse, the tax drag compounds over time, eating away at after-tax wealth.

The long-term impact? It could eventually eclipse the initial investment. Don't underestimate the power of compounding taxes—plan wisely to minimize the cost.

Plan for a good start to 2025

There's no time like the present to plan for today, tomorrow and the longer term. Whether it's the impact of taxes on capital gains, instilling the lesson that taxable interest is taxable as income, the need to define legacy plans, or the general need to better plan the impact taxes are having on your clients, there is no better time than now.

One way to get your clients thinking about tax management is to run a tax analysis on their portfolios. It can be hard for an investor to conceptualize the impact of tax management until they see the results. By partnering with us to do the analysis and run the proposal, you are making the transition to tax management easier for the client.

With a proposal in hand, you can show your clients how their allocations would differ, what that means from a risk/return perspective, and the impact the changes would make on their overall wealth.

If you need more guidance on how to broach the above topics with your clients, our Tax Smart Investing Guidebook is replete with charts, tables, case studies and more. Or reach out to your regional Russell Investments representative.

Disclosures

These views are subject to change at any time based upon market or other conditions and are current as of the date at the top of the page. The information, analysis, and opinions expressed herein are for general information only and are not intended to provide specific advice or recommendations for any individual or entity.

This material is not an offer, solicitation or recommendation to purchase any security.

Forecasting represents predictions of market prices and/or volume patterns utilizing varying analytical data. It is not representative of a projection of the stock market, or of any specific investment.

Nothing contained in this material is intended to constitute legal, tax, securities or investment advice, nor an opinion regarding the appropriateness of any investment. The general information contained in this publication should not be acted upon without obtaining specific legal, tax and investment advice from a licensed professional.

Please remember that all investments carry some level of risk, including the potential loss of principal invested. They do not typically grow at an even rate of return and may experience negative growth. As with any type of portfolio structuring, attempting to reduce risk and increase return could, at certain times, unintentionally reduce returns.

The information, analysis and opinions expressed herein are for general information only and are not intended to provide specific advice or recommendations for any individual entity.

Russell Investments' ownership is composed of a majority stake held by funds managed by TA Associates Management L.P., with a significant minority stake held by funds managed by Reverence Capital Partners L.P.. Certain of Russell Investments' employees and Hamilton Lane Advisors, LLC also hold minority, non-controlling, ownership stakes.

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