Tax Planning

Identified Unknowns: Tax Planning Amid Unsure Legislation Modifications

“How can I advise my clients on tax planning when there is so much uncertainty about future tax laws?” This…

“How can I advise my clients on tax planning when there is so much uncertainty about future tax laws?”

This is a question financial advisors are asked on a daily basis. If this is a question you have asked yourself, consider asking this instead: When has the tax code ever had certainty? Asking the tax code to have certainty is like asking the stock market or interest rates to just sit still for a few years. Compared to the markets, the tax code is the most stable piece of a client’s financial life, as it only tends to change once or twice per administration.

The version of the Build Back Better bill that is circulating on Capitol Hill has stripped out several areas originally proposed in 2021, to the point that only a small number of areas would be affected, assuming the bill is eventually passed, either in part or in whole. Even the initial wish list of changes only covered a sliver of the full tax code, so at no point were financial advisors left without meaningful tax planning that they could be doing with their clients.

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Tax Now or Tax Later

Whether specific to the topics still in the proposed legislation or not, one area advisors can help their clients save on taxes is through taking control of the timing of when taxes are paid.

Essentially every client working with a financial advisor has two tax concerns, although usually only one that they consciously express. The first is: “How much do I have to pay in taxes this year?” Like the siren song of Greek mythology, a singular focus on paying less in taxes this year has wrecked countless tax strategies, resulting in enormous amounts of unnecessary payments to the IRS. The second, and often overshadowed, question is “How can I pay less in taxes over my lifetime?”

A classic example of the first concern overriding the second is the conventional wisdom of maximizing deductible IRA or 401(k) contributions. Financial advisors everywhere must be screaming in protest at the suggestion. “Defer, defer, defer” has been a foundation of tax planning for decades. While this might be the view of the many, is it in fact a good tax strategy?

Laying out an example for clients can help them make fiscally sound decisions for the long term. A hypothetical client with the ability to contribute $15,000 to their deductible IRA or 401k at their 24% marginal tax rate saves $3,600 in income taxes this year. Conversely, the client could put that same amount in a Roth IRA account. Which should they do? Before you bust out your Monte Carlo simulator, make it really simple and put in terms the client could understand:

“Would you rather pay $3,600 more in taxes this year and put $15,000 in your Roth IRA, or pay $14,400 in 20 years when your traditional retirement account has potentially doubled and doubled again to $60,000?”

[Read: Tax Deductions for Financial Advisor Fees]

Again the screams ring out: “But wait, what if tax rates change, or the markets don’t grow, or consider the time value of money, or if the client invested the tax savings?” First, it’s a rare occurrence for clients to actually invest their tax savings. Second, has a client ever wished for less tax-free money?

Yes, there are a million other variables, but the key from this example is that clients need to take action. Clients need specific advice, despite the uncertainty of what tax rates might be in the future. Great advisors evaluate individual client situations and recommend a course of action. There is no one-size-fits-all approach, so trying to follow one is not adding value to your clients. Along with the math, advisors need to consider the behaviors that clients will actually implement. If the outcomes will be similar in how much ends up in a client’s account during retirement, why not err on the side of tax-free money?

Over Time or All at Once

This same scenario plays out for harvesting long-term capital gains and Roth conversions. Too many clients are sitting on massive amounts of unrealized gains and retirement account balances because they are so afraid of paying taxes now, only to pay even more in taxes later.

A great question to ask clients is whether they expect to withdraw a large amount from their accounts later in life. No one can predict the future. Some day they are going to need a big lump sum of money. Hopefully this is for something fun, like purchasing an RV to travel around the country, but maybe it will be for something less fun, like having to pay for life-saving medical treatment. In either case, if they pulled out $100,000 all at once, they’ll get killed in taxes. If instead they can take out a piece of that each year, they’ll end up paying far less in taxes.

Again, this is not simply about the numbers. Focus on the actions that taxpayers will follow through on. A 50-page financial plan with dozens of scenarios and possible outcomes charted on colorful graphs may look nice, but a one-page plan with clear instructions that a client will actually follow through on will provide more value every single time. Crunch the numbers and make sure your recommendations are sound advice, but remember you are working with people.

[Read: 5 Strategies for Charity-Minded Clients in 2022.]

Reading the Crystal Ball

While tax experts hear the excuse about tax law uncertainty on a regular basis, the question everyone always asks is: “What will the tax law be in the future?” A response, which can be modified for use with your own clients, is: “I hate to admit this, but neither the president nor Congress has called me for advice on the new tax laws, so for now I’m staying focused on what we can control.”

Regardless of the type of clients a financial advisor serves, taxes will be a factor. This means tax planning has to be part of the equation for an advisor to feel confident their client is being taken care of. Value can be added to a client relationship by advisors who stay up to date on pending changes at the point they become law. That does not mean tax planning is put on hold until some magical date in the future when nothing will ever change again. That day will never come.

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Known Unknowns: Tax Planning Amid Uncertain Law Changes originally appeared on

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