Does Your Advisor Understand Taxes?
Let’s begin with three questions about taxes and how they impact your life.
- Are taxes one of your biggest expenses each year?
- Would you prefer to pay as little in tax over your lifetime as legally possible?
- Do almost all your financial decisions have at least some impact on your taxes?
For most individuals who have or are thinking about hiring a financial advisor, the answer to all three questions is a resounding YES!!! Let me ask you another question: When is the last time your financial advisor asked you for your tax return?
Key Takeaway:
Taxes will likely be your LARGEST lifetime expense. Your advisor needs to understand your specific tax situation.
We believe that any advisor providing financial advice and helping guide you to a successful financial future should be asking for and reviewing your tax return each year. The taxes you pay will significantly impact your future, and are too important to be ignored.
As your financial guide, we believe we should ensure we understand how our recommendations will impact your taxes and whether there are additional recommendations that should be made to reduce your taxes. An advisor who does not understand your tax situation is missing a large piece of your financial puzzle.
Recently we’ve seen a few examples of unintended tax consequences resulting from advice people received from other advisors.
- Roth conversions where the advisor did not understand the client was having their best income year and was in the highest tax bracket. Accordingly, the client paid the highest tax rate on the conversion when they could have waited and paid much lower rates in the years to come.
- Tax withholdings from a Roth conversion before age 59.5 where the advisor did not understand that the portion withheld for tax is considered a distribution subject to taxes and penalties.
- Real estate sales where the taxable gains resulting from the sale were not fully understood. The additional gains resulted in the individual paying more than double the tax initially expected.
- Portfolio rebalancing resulting in unnecessary capital gains that could have been entirely avoided by using retirement accounts to facilitate the rebalance.
There is no shortage of potential tax implications of financial advice; these are simply recent examples to demonstrate the importance of understanding the tax implications of recommendations made.
Key Takeaway:
Nearly all financial advice has tax implications. Your advisor needs to know how their advice will affect your taxes.
Won’t my CPA give me advice?
While many individuals rely heavily on their CPA and assume their CPA will provide tax planning guidance, their CPA cannot change what has already been done. If a poor recommendation has already been implemented, your CPA cannot change it at tax time. You will be stuck with the tax consequences.
Your CPA is typically preparing hundreds of tax returns from February 1st – April 15th, and they rarely have time to analyze planning strategies that would save you money during that time of year. If you or your financial advisor are not working with your CPA throughout the year, it is unlikely you will receive the detailed and proactive tax planning advice you need.
If you are working with a financial advisor who follows a comprehensive process and takes the time to learn about all areas of your finances beyond just investments including insurance, estate planning, and legacy goals, they will typically know more about you than your CPA. Accordingly, we believe the financial advisor is the individual who should be taking the lead to help make sure your tax situation is in order. Your financial advisor can then utilize your CPA as a resource when necessary.
Key Takeaway:
CPAs do not have time for detailed tax planning during February-April, and they cannot fix bad planning retroactivly. You must be proactive throughout the year to create an effective tax plan.
What to do?
To be clear, taxes aren’t the only important consideration when determining a plan for your financial future, and no one should pursue strategies simply because of the tax treatment. Ultimately the entire impact on your finances must drive the decision. However, taxes do have a substantial impact on the final outcome and must be considered when determining the best course of action.
Since we believe in understanding the tax consequences of decisions prior to making them, we recommend working with an advisor who is committed to understanding your tax situation and is proactive in identifying tax planning opportunities available to you. Finally, they should be dedicated to understanding the tax ramifications of any financial recommendations they make.
If you would like financial advice from individuals who understand the tax impacts of the advice they give, we would love to connect to see if what we do can benefit you.
