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This article is the fourth in a series of the seven most common mistakes financial advisors make on tax planning with clients.
In my previous article, I discussed the mistake of making tax planning difficult for the client (and their tax preparer). This week, I want to draw your attention to a mistake that is most commonly made by tax preparers, but trips up financial advisors as well: doing tax planning one year at a time.
When it comes to preparing and filing a client’s tax return, the focus is naturally the 12 calendar months of the prior tax year (with a few allowances for carry-forward losses, etc.). Unfortunately, the requirement to fulfill the annual tax filing can lead to a singular focus on what has happened versus what will happen.
A small step in the right direction is that once I know what happened, I focus on what needs to happen this calendar year. For example, I may notice that last year a client who is married filing jointly (MFJ) had adjusted gross income (AGI) of $173,000 (line 11 of the 1040) and taxable income of $127,000 (line 15 of the 1040). Assuming their current-year numbers are basically the same, I can have a discussion with the client about Roth contributions (MFJ income limit of 214,000), harvesting capital gains at 15% (MFJ limit of 517,200 of taxable income) and/or Roth conversions up to the top of their 24% marginal tax bracket.
This discussion sounds something like this:
Mrs. and Mr. Client, after reviewing your tax return for last year, we’ve identified three potential tax saving strategies and today I’d like us to decide on the most valuable one for your goals, which are…
This step alone will put you in the top echelon of financial advisors, but it’s only the beginning. The next step is not to do a 40-year, 100-page tax illustration, but rather to shift the client’s focus forward to their next tax milestone. For example, let’s say you have a client who wants to retire in three years at age 64. When they retire, their tax situation will change, as it will again when they start Social Security, pull money from their nest egg and/or have to start taking required minimum distributions at age 72.
This milestone-based discussion sounds something like this:
Ms. Client, in three years, when you retire your tax situation will be substantially different as you shift from getting a paycheck to taking income from your nest egg. In the years before you retire, we will want to do A, B & C, and each year after you retire we will look at D, E & F.
This approach shifts the client’s focus, while also demonstrating the value you are delivering, not just this year, but for many years to come. Similarly, when meeting with prospects, you can use this same approach to make them aware of all the tax strategies that they didn't even know exist. A version of this for prospects sounds like this:
Mr. Prospect, what will be your strategy for reducing the tax hit caused by starting your Social Security?
Another example of shifting your tax focus to the future is by reminding clients (and yourself), that tax reductions from the Tax Cuts and Jobs Act (TCJA) will expire at the end of 2025, which means that without any new legislation, tax rates will go up in 2026. This provides an additional incentive to “pay-the-devil-you-know” by doing Roth conversions and/or gains harvesting at today’s rates versus waiting until rates go up in a few years.
Depending on the ages of your clients, many of the advisors with whom I work will start to make clients aware of their RMDs as much as a decade in advance of their start date (typically age 72):
Mrs. Client, in many years when you reach age 72, the IRS is going to require that you pull out a certain amount of money from your nest egg each year so that it can get its piece of it in taxes. With your nest egg of $1,000,000 your RMD will likely be $36,000 each year. Instead of waiting until the IRS requires you take this money out, I recommend we begin taking out $XX (whatever is left of their current tax bracket), which will reduce your future RMD and create for you a bucket of tax-free money.
With each of these examples, even if the client declines to take action (which isn’t unusual as the pain of paying taxes now versus delaying can feel like too much), you still win as the advisor because you’ve demonstrated again the value you provide.
Action items
In every client and prospect meeting, have at least one bullet point on your agenda to discuss, even briefly, upcoming tax milestones, including RMDs and the expiration of the TCJA in 2026. When discussing a tax milestone, have strategies/recommendations for immediately before and after the milestone. Specific to RMDs, have a one-page illustration of how the RMD works. Lastly, while you are looking at future tax years, be sure to avoid mistake #3 – skipping the tax strategies that work versus the ones that are sexy.
Come back next week for part three 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. Want more on the most common mistakes advisors make on tax planning? Join Steven for an online session on April 27th and use code "AdvisorPerspectives" at checkout for an exclusive discount.
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Advisor Perspectives welcomes guest contributions. The views presented here do not necessarily represent those of Advisor Perspectives.
