Does your investment advisor ask nosy questions about your income tax return? If not, he should be! Taxes and investments go together like soup and sandwich – but it may surprise you just how much you could lose by not discussing tax planning along with investment strategies.
Whether you are young or old, in a high or a low income tax bracket, you can benefit by working with an advisor who bases her advice on knowing – and understanding – everything possible about your financial situation. Since income taxes will probably be one of your biggest annual expenses at some point in your life, it can be especially harmful to your overall fiscal fitness to leave this critical information out of the equation. So what do taxes have to do with your investments? Here are three examples:
Roth conversions: If you have a taxable IRA or even a 401k from a former employer, not only can you save money by converting it to a Roth IRA, but you’ll also reap other benefits, such as the ability to leave your money alone when you reach age 70-1/2. Because you pay taxes at conversion (which I’ll cover in an upcoming column), it’s usually best to convert chunks of it in low-income years. Has your investment advisor discussed whether a Roth conversion would be appropriate for you? If not, you could be missing out.
For example, Jolene came to us for tax preparation and a free review of her IRA. Since she retired a few years ago, she has not owed taxes. A five-minute review told me she should have begun moving money from her IRA into a Roth the year after she retired. This simple strategy would have cost her little or nothing now but it would have saved her thousands of dollars in future taxes. Unfortunately, no one had bothered to let her know.
Roth conversions also work well for business owners with income fluctuations and young people changing jobs in low tax brackets. When in doubt, it’s always good to ask!
Gains and losses: Your investment account may be stuffed full of long-term gains. However, if your advisor doesn’t know you have a long-term capital loss carryover on your return, he may be holding on to those profits. This often happens when you’ve changed advisors after losing money (think 2008-2009) and your current advisor doesn’t know your tax situation. Long-term capital losses can be deducted at a maximum of $3,000 annually on your tax return. But if you have gains to offset them, you can deduct more.
This happened to a new client recently. His investment statement showed that his stocks were up about $25,000 and he was reluctant to sell and pay taxes. A glance at his tax return showed me he had a loss carryover of about $30,000 from selling near the bottom of the housing bubble. The good news was that he could sell everything, upgrade to a much safer balanced equity mutual fund portfolio, and pay no taxes. I call that a win-win-win. (On the other hand, the not-so-good news was that his former advisor was clueless about this possibility.)
Social Security: As you near retirement age, your advisor can play a key role in helping you decide on the best time to start claiming benefits. You will pay taxes on up to 85% of your Social Security benefits based upon your taxable income. Planning ahead can not only help you save taxes but also net you higher monthly benefits. (And don’t forget that your Medicare costs also depend upon how much you make.) By coordinating income, dividends, investment gains and losses, money you take out of your IRA, etc., you can cut your tax bill and boost your income, just when you need it the most. This process will also give you clarity about your finances to help ensure you maintain the standard of living you have worked and planned for.
Does your advisor have to be a CPA? Not necessarily. But she should have a good knowledge of the tax code, especially as it pertains to investing, and take an interest in you beyond what’s in your portfolio. Consider asking your advisor and your CPA to take a joint look at your financial situation at least annually and make recommendations to you.