The buzzword for wealth management in 2021 is uncertainty. With potential tax changes on the horizon, there are many questions about which asset classes are doing well, staying flat or stalling, permeating almost every aspect of wealth management and investing.
As always, supporting customers in this environment requires clear and direct communication and an organized approach. There are a variety of considerations, goals, and preferences to discuss. In terms of taxation, however, the following four areas of focus should be relevant for the broadest clientele.
1. Realization of short and long term gains and losses
Deciding when to sell an asset in order to record taxable gains and losses can be difficult in any setting. First, an investor needs to look at current and future returns to decide whether to take a profit or loss this year or postpone it to the next year. You also need to be careful about the type of asset: can only the excess gains or losses in a particular individual asset class – short or long term – be used to offset gains or losses in the same asset class? ?
But this calculation becomes even more tricky in view of the uncertainty about a possible increase in the capital gains tax rate. The Biden government is aiming to increase this rate from the current 20% to 28%. This change would decrease the value of realized capital gains and increase the value of realized capital losses.
Timing is everything. In our view, it is very unlikely that any action will be taken by at least autumn 2021. In addition, a retrospective change in the withholding tax rate is questionable. In any event, investors and their advisers must discuss the risks and rewards of accelerating or delaying capital gains or losses.
2. Charitable donations
Philanthropy is a goal for many investors in any market. But in an environment of changing tax rules and rates, charitable strategies need to be carefully considered.
Given the strong surge in markets over the past few years, many investors may hold low-based and high-valued securities. A donation can be far more tax efficient than selling it and then donating the proceeds. Note, however, that the rules differ depending on whether the securities are publicly or privately traded.
When donating a valued public security, the rules are relatively simple: the donation of the property avoids any capital gains tax. This means that the value of the donation is actually 20% higher than it would otherwise have been; 28% higher if and when capital gains tax increases.
Customers can also donate highly valued private securities. However, the rules here are more complex and can be administratively complex. Therefore, before an advisor donates private securities, he must make his clients aware of additional steps and inform them of the rules in order to avoid risks and pitfalls.
Finally, customers should take a close look at the funds recommended by donors. These vehicles allow the investor to fund a donation today without naming a specific charity – recipients can be named later.
3. Change of residence
Digitization across the global economy has made it easier for people to live and work where they want, a trend that has accelerated exponentially during the global pandemic.
Many clients work remotely and have moved from high-tax areas to locations with low or no state taxes. Such a shift has the potential to have a profound impact on investment results and strategies.
For customers who have moved, advisors can first help determine whether they can announce and document this move. With the clear determination of the new main residence, an investor has a better chance to refute the income claims of the state or city administration from the old residence.
From there, the discussion should turn to the mix of assets in the portfolio. For example, tax-free municipal bonds, which might have made sense in a high-tax country in the past, are no longer preferable to other taxable securities.
4,529 college plans
529 college plans available in each state allow a single investor to donate up to $ 15,000 per year for each beneficiary. Since it is essentially a gift, the $ 15,000 amount is subject to the gift tax limit and, as such, can go up to $ 30,000 per year if it is from a married couple. The money is invested and is exempt from income tax and capital gains tax when used at a later date to pay tuition, books, room and board, and other mandatory expenses.
With possible tax hikes on the horizon, this option deserves careful consideration. Also note that a relatively new provision introduced by the Tax Cuts and Job Act now allows beneficiaries of 529 plans to withdraw up to $ 10,000 per year to pay for private elementary or secondary school tuition (withdrawals are only on Tuition fees limited).
Those with truly high net worth, or those having a particularly lucrative year, may be able to take advantage of another important provision within the 529 plans and consider superfinancing as a 529 plan. In particular, investors are allowed to make contributions using the five-year gift average. This not only reduces the donor’s taxable income for the current year, but gives the recipient five additional years for the fund to grow.
Note that there is an overall cap on investing in such a plan and that this amount varies by state. However, one possible option is to open 529 plans in multiple states.
The above list is by no means exhaustive. There are numerous additional circumstances and investor interests that need to be part of the conversation. But in an environment where tax rates and policies remain uncertain, we believe these are some of the most common considerations that should be an important part of an informed conversation with customers.