With another tax season in the rear-view mirror, the last thing most people want to think about is tax planning. But here’s the honest truth: wise tax planning is a lifelong activity and pays untold and tangible benefits when properly attended to.
In more than three decades of working with clients, we have found that year-round diligent tax planning offers multiple teaching opportunities as to how we might best handle our assets and create maximum financial flexibility.
Contrary to popular belief, housing, children, and investment costs are certainly not our greatest lifetime expense. Taxes are. And with investment returns moderating, controlling one’s biggest expense should become a number one priority.
Consistent and methodical tax planning also lets people focus on their security. Online security was barely a concern a decade ago but today it’s a 21st-century hazard. Tax filing often provides a window into the underworld of identity theft. As cited in multiple news reports, the massive IRS hack of taxpayer accounts initially reported a year ago has grown from 114,000 to more than 700,000 accounts as of late February – with an estimated 500,000 more targeted.
It wasn’t until earlier this year that the IRS began contacting those impacted taxpayers, which means their personal information – including social security numbers and dates of birth – had been exposed and vulnerable for months on end. Unfortunately, there is no surefire way to prevent online hacking, but advisors and clients can work together to minimize potential damage and strategically protect confidential information and access to valuable assets.
Another benefit of wise tax planning is the result of effective communication between tax counsel and financial advisors.
In the mid-20th century, Albert Einstein stated, “the hardest thing in the world to understand is the income tax.” We don’t know if Einstein had a good tax accountant but he would surely feel his world-changing General Theory of Relativity was child’s play compared to the inhumanely complex and byzantine tax code we are saddled with today.
Today the best strategy in deciphering the code comes from a strong financial triangle including the client, an advisor and proactive and independent tax counsel. When clients coordinate the best of tax code fluency with advisors who understand their financial goals and risk levels, it can often lead to the best outcomes.
Our goal, first and foremost, is to minimize tax surprises for clients. This is not always an easy task. In fact, it is sometimes difficult to appreciate the benefits of prudent tax planning until the results can be quantified well into the future.
We expect that future tax rates will be higher, so why would anyone fail to plan now for an increased tax burden?
Ask yourself the following questions for your clients: Are you monitoring the balances between tax-deferred, tax-free, and taxable assets to optimize tax efficiency in the future? Have you shown them Roth IRAs? Do they understand the estate planning benefits that may come with Roth holdings? Do you regularly monitor and rebalance the asset types held in taxable, tax-deferred, and tax-free accounts? Are you educating your clients to understand why asset location may be more important than asset allocation? Is “tax alpha” a component of your financial planning?
Without a doubt, we live in a much different economic climate than Einstein did 75 years ago before IRAs had been created. Over your clients’ lifetime of working and investing, proactively managing their tax efficiency can help minimize life’s highest expense while maximizing their potential to reach their goals.
This opinion was coauthored by Casey Snyder, a financial consultant with Wells Fargo’s Sedoric Group.