Three Reasons why your Advisor should be reviewing your Tax Return each year.
“It’s not how much money you make, but how much money you keep, how hard it works for you, and how many generations you keep it for.” – Robert Kiyosaki
That is one of the most powerful quotes that often swirls in my head regarding tax planning. “Tax planning?”, you might be thinking, “I have a CPA or an accountant for that”. Yes, and we trust and leverage your CPA or accountant heavily in providing tax advice, and to handle your tax preparation. However, as a fiduciary, we are bound to a standard that places our interest below that of our clients – this means giving the best advice we can. For us to do that, we need to know your tax situation. Your current and future tax brackets, sources of income, and related tax items can strongly impact the investments we recommend and the strategies we may want to implement. This is the reason we are so passionate about reviewing our client’s tax returns each year – while it is important to review, and ensure accuracy, it is even more-so that we utilize this invaluable information to help make wise financial decisions, saving you tax dollars in the short-run and helping to realize your financial objectives in the long-run.
Here are three reason we would want to review your taxes:
1. Understanding your Marginal Tax Bracket
Your taxes increase incrementally by what is known as a “progressive tax” system – that is, the amount of tax paid on your next dollar earned. We call this rate your Marginal Tax Rate, which, combined with your risk tolerance, helps us determine how to position your taxable investments. Perhaps your marginal tax rate is 32%. Well, by positioning equities within your taxable account we can help you are taxed at the more favorable long-term capital gain and qualified dividend rate of 15%, compare this to your 32% (plus state!) marginal rate you are taxed on with ordinary income and interest income. Related to this, how much fixed income are you carrying within your taxable account compared to your IRA’s (qualified accounts)? We’ve had some clients with their large, fixed-income positions held within their taxable account. This costs them a significant amount each year, as they are paying ordinary income tax rates verses the lower capital gain rates. While it may take more work and a thoughtful approach, we will never make blanket decisions when managing our clients’ investments, because we understand the tax impact those decisions can have. Many small decisions add up greatly over a long period of time, and we are seeking to maximize long-term return.
2. Do You Expect Any Major Changes to Your Income?
It is important to consider any foreseen income changes coming down the pipe, as these changes can determine whether (or not) to implement various strategies or recommendations, and/or effect the timing of many financial decisions. Some clients may have a drop in taxable income when they step away from the workforce, or they may have a few “gap years”, where they take some time off, or take a lower paying (but, lower stress) job. Whatever the life event, they find themselves in a lower tax bracket. In this situation there are a couple strategies that come to mind. One, is selling appreciated securities at the zero percent capital gains rate – Yes, 0% capitals gains. In 2021, Married couples with Taxable Income under $80,800 may pay zero percent on long-term capital gains. For one client of ours, we’ve been working with them to sell appreciated securities, pay Uncle Sam 0%, and pay off the remainder of their home over 3-4 years. Another strategy is doing a Roth conversion. Let’s say we have a married couple in the 12% bracket, but their kids are high earners in the 24% or 32% bracket. If the kids inherit an IRA, they will have 10 years (under the SECURE Act) to completely distribute the account, and they will pay taxes on these distributions at their higher tax rate (Sometimes pushing them into even higher tax rates). How can we save those funds from being sliced and diced at those high rates? Well, what if we had the parents take the distribution in their lower 12% bracket, then do a Roth conversion? Once within their Roth, when the kids eventually inherit the money, they won’t pay any taxes on it. We just saved the family 20% in taxes.
3. Are You Maximizing Your Qualified Contributions, and Which Qualified Account is Best?
This may not sound exciting, but they call these “the basics’” for a reason. A great way to prepare for retirement is to ensure you are taking full advantage of the tax savings afforded by 401K’s, 403B’s 457’s, IRA’s, Roth’s, SEP IRA or SIMPLE IRA’s. But, how do you know which qualified plan should be utilized? Well, after we determine what plans are offered by our clients’ employer, we then take a close look at their marginal tax rate, age, and future income estimation in order to provide a recommendation. Should they be contributing pre-tax dollars via 401K or IRA; or their after-tax dollars via a Roth? Can these contributions be maxed-out at $19,500 for a 401K (+$6,500 if over 50), or $6,000 if IRA or Roth (+$1,000 over 50). For self-employed individuals we look at their ability to max-out a SEP IRA or perhaps even a Defined Benefit Pension Plan. Perhaps our client’s spouse does not work or has little or no earned income of their own; they often do not know that they may still qualify to contribute under special Spousal IRA rules. Knowing the tax situation helps with many of these decisions.
Proper Tax Planning is Key!
There are many other reasons why we would advise to let you have your financial advisor review your tax return – and while we hope for (and generally do find) a clean ‘bill of health’ when we review our client’s returns, we’ve also found missed deductions, missed 529 contributions, double-counted income from rentals, and more. Time taken to carefully review work after it is performed is almost always time well spent, especially when that person reviewing is someone who stays well connected to your financial life and knows what to look for with your specific situation. You may find some of this tax stuff odd, but we find it ‘exciting’ when we do Income Tax Reviews for our clients. Looking at items such as marginal tax rate, tax due, loss carry-forward, depreciation on rental properties, Social Security taxation, etc. helps us understand our clients’ financial situation at a deeper level and the more we know about our clients, the more we can provide value-add suggestions to help keep their money working for them!
About Stewardship Wealth Advisors
Stewardship Wealth Advisors is an independent, fee-based comprehensive financial planning firm dedicated to empowering clients to steward their wealth well and maximize their hard work and dedication. With decades of experience, our team of advisors builds a foundational relationship to create a personalized financial plan to help their clients reach their goals and achieve financial independence. To learn more about what we do and how we can help you, connect with us online.
Information provided is hypothetical only, provided for informational purposes only and is not intended to be a projection of current of future performance or indication or future results. The information provided is not based on actual current or past clients. All situations are unique, and results will differ depending on individual situation.
Advisory services are offered through Stewardship Wealth Advisors, a Registered Investment Advisor in the State of Arizona.