Most of us breathe a sigh of relief when our tax returns are finally filed. But in assessing the refund or payment you made to the IRS this year, could you have done better? Were there any unwelcome surprises?
Integrating tax preparation with the wealth planning handled by your financial advisor can not only help to avoid unexpected tax issues—it can uncover strategies to reduce taxes and optimize your wealth. In this article, our Director of Tax Services, Zach Gordon, discusses the advantages of coordinating tax planning and wealth management.
Think long term.
Tax preparation needs to be conducted with a long-term outlook in mind to pair effectively with wealth management. Personal income taxes can be prepared by an accountant in three general ways. Tier 1 tax preparation focuses on strict compliance to the tax code with the primary goal of satisfying the IRS tax return filing standards. The tax preparer puts the right numbers in the right boxes but otherwise adds little value. Tier 2 tax prep addresses the taxpayer’s specific situation for the tax year, proactively identifying deductions and other situations that can minimize tax liabilities for the current filing cycle only.
Tier 3 tax prep, which is the approach we take at Leelyn Smith, involves looking out over a longer time horizon, ranging from three to 10 years, and crafting a deliberate and enduring tax plan for those periods. This longer perspective allows for a more effective integration with long-term wealth planning.
Taking full advantage of this integrated tax planning approach requires open, detailed communication between a client’s accountant and their financial advisor. This dialogue can help uncover blind spots that one professional may overlook in their targeted focus area and ensure tax planning goals are consistent with wealth planning and cash management goals.
We like to say that a client can hire the very best CPA and financial advisor, but if those two professionals are siloed, then you’re likely missing out on some great planning opportunities. Coordination can lead to more tax-efficient actions both in the current tax year and well into the future with the objective of paying the lowest amount of taxes over the client’s lifetime. One of the most obvious benefits of coordination is framing the pros and cons of generating tax liabilities now or later. Knowing a client is facing a large tax bill because of capital gains from investments in a certain year, for example, an accountant or financial advisor can suggest delaying other actions that will generate taxes, such as a real estate sale, to a future year when they can be offset by losses from other assets.
Weighing a Roth IRA.
Roth conversions of retirement savings accounts are a common issue facing clients nearing or already in retirement. Roth IRAs allow for tax-free growth of retirement assets and tax-free withdrawals once age or holding period requirements are met. The catch is that taxes must be paid on the conversion balance at the individual’s marginal rate at the time of the conversion.
Financial advisors can help project a client’s future income and subsequent tax bracket, helping their accountant determine the optimal timing of a conversion. The financial advisor can also ensure cash is available to pay taxes on the conversion, which avoids having the client withhold a portion of their conversion to cover taxes.
Getting creative with charitable giving.
When executed well, philanthropy can be an effective tax and estate management tool. A client with sizable unrealized gains in single stocks can remove a portion of those profits from their estate by donating appreciated shares. But such a move may not make sense in every situation. A tax preparer in consultation with a client’s estate planning attorney and financial advisor can determine the best option for a client who is already itemizing deductions, for example, compared to another client taking the standard deduction and required minimum distributions from their retirement plan. In the latter case, the client can substitute $105,000 of those RMDs to make a qualified charitable distribution.
For new trustees, we often recommend assembling all their professional advisors in one room. At a minimum, this could include their estate planning attorney, wealth manager, accountant, and perhaps their private banker. These specialists should get to know each other and share information that can make an ongoing collaboration even more valuable for your long-term wealth plans.
Minimizing investment-related taxes.
For clients in the asset creation phase of their financial life, assessing their overall wealth picture with the input of both their financial advisor and accountant can allow them to implement an asset location strategy. More growth-oriented investments that tend to generate low levels of income, which is taxed at marginal rates, are best held in taxable accounts. Investments such as bonds and dividend-paying equities that generate higher levels of income are better suited for tax-deferred accounts such as a traditional IRA or 401(k).
Reducing the taxes generated by investments is another smart way to enhance wealth. Swapping mutual funds for exchange-traded funds in taxable accounts can remove capital gains exposure that is usually out of investors’ control. ETFs are not only more tax efficient, as they do not generate capital gains until sold, but they also carry lower ownership costs than mutual funds.
Our integrated approach.
Truly benefiting from integrated tax planning and wealth management requires the contributions of advisors with complementary expertise. Leelyn Smith has built its business model around this integration, offering investors sophisticated tax preparation services alongside personalized wealth management. We craft custom financial plans for our clients and take their unique tax considerations and long-term goals into account when implementing our investment strategies. Contact us to learn more about how to transform tax preparation from an annual chore into a long-term wealth building opportunity.
Content in this material is for general information only and not intended to provide specific advice or recommendations for any individual.
This information is not intended to be a substitute for individualized tax advice. We suggest that you discuss your specific tax situation with a qualified tax advisor.
A Roth IRA offers tax deferral on any earnings in the account. Qualified withdrawals of earnings from the account are tax-free. Withdrawals of earnings prior to age 59½ or prior to the account being opened for 5 years, whichever is later, may result in a 10% IRS penalty tax. Limitations and restrictions may apply.
Traditional IRA account owners have considerations to make before performing a Roth IRA conversion. These primarily include income tax consequences on the converted amount in the year of conversion, withdrawal limitations from a Roth IRA, and income limitations for future contributions to a Roth IRA. In addition, if you are required to take a required minimum distribution (RMD) in the year you convert, you must do so before converting to a Roth IRA.
ETFs trade like stocks, are subject to investment risk, fluctuate in market value, and may trade at prices above or below the ETF’s net asset value (NAV). Upon redemption, the value of fund shares may be worth more or less than their original cost. ETFs carry additional risks such as not being diversified, possible trading halts, and index tracking errors.