Can We Talk? During Tax Season, Your Financial Adviser and Your Tax Professional Need to Communicate
Even with the stock market gyrations we’ve seen of late, tax season is still headed our way. As you prepare for your annual reckoning with the IRS, it’s more important than ever that your financial adviser and your tax adviser have open lines of communication. The more these two financial professionals can be on the same page as you prepare your return and other documents, the better you’ll fare, not only in tax savings but also in the long-term growth of your financial resources.
Here are a few of the ways that good, clear communication between your financial/investment adviser and your tax expert can directly benefit you.
1. Tax-loss harvesting. Even in a good market year, you’ll probably have some assets in your portfolio that haven’t made money. In consultation with your tax professional, your financial adviser can review your holdings and identify positions that could be sold at a loss. Why take a loss, you ask? Because such strategic harvesting of capital losses can help you offset gains in other areas. Your financial adviser can help you make smart choices for which losses to take, and your tax expert can provide the big-picture assessment of how much is needed.
2. Help with required minimum distributions (RMDs). Retirees who are withdrawing money from traditional 401(k) plans, IRAs, and other tax-favored plans must be conscious of the required amount of funds they must pull out each year, beginning at age 72 (no longer 70.5 thanks to the SECURE Act). While your accountant is probably familiar with these requirements, they may not have an encyclopedic knowledge of your asset mix within these accounts or what other income you have that should be taken into consideration. On the other hand, your financial adviser can look at the range of investments in your portfolio and recommend withdrawal strategies that take into account both tax requirements and the particular characteristics of your assets. It may make sense, for example, to take the withdrawal from one mutual fund held in an IRA account as opposed to another mutual fund in the same account. Because your financial adviser is familiar with your asset mix and its place in your financial strategy, they can help your accountant make the best, most tax-savvy choices for handling your RMDs.
3. Strategies for optimal taxable–tax-exempt income mix. Though this is something you should wait until tax time to think about, it’s important to know whether or how much you should be incorporating tax-exempt income streams into your asset mix, with regard to your fixed-income (interest-bearing) investments. Interest from sources like municipal bonds is free from federal taxation for most individuals, and even though the coupon rate (interest) is usually lower than a taxable bond, the tax-equivalent yield can be higher for those in elevated tax brackets, because of not having to pay income tax on the earnings. Your financial adviser and your accountant need to have a shared understanding of your tax bracket so that your ratio of taxable and tax-exempt income is optimal for your unique situation. And by the way, this becomes even more important as you approach retirement; in some cases, you can expect to be in a lower tax bracket during retirement, and the tax-exempt investments that made sense before may be less advantageous.
4. Help with alternative minimum tax. For taxpayers with higher incomes, the alternative minimum tax (AMT) is an ever-present consideration. Many of the tax breaks and deductions enjoyed by those in lower brackets are unavailable if you are subject to the AMT. While there’s not much you can do once you find out you’re subject to the AMT in a given year, you can plan ahead for the next year to reduce the chances of being caught by it in the future. Reducing your adjusted gross income (AGI) by such tactics as increasing contributions to IRAs, 401(k) plans, 403(b) plans, and health savings accounts (HSAs) is one way of reducing your AMT liability. You can also help yourself by controlling your capital gains as much as possible (see “tax-loss harvesting,” above). Your accountant will be the one who tells you if you’re subject to AMT, and your financial adviser can help put you in a more advantageous situation for future years.
5. Minimizing taxes on Social Security. You’ve worked long years and paid thousands into the system, and in retirement, it’s time to start receiving the benefits in the form of Social Security income benefits. For some retirees receiving Social Security, benefits are either non-taxable or taxed at a relatively low rate. But for those with sources of income such as IRAs, 401(k) plans, or even part-time work (increasingly common for retirees), a portion of Social Security benefits will probably be taxable. For single individuals with income between $25,000 and $34,000, half of your Social Security income is taxable ($32,000–$44,000 for married couples filing jointly). If you file individually and your income is above $34,000, 85% of your Social Security income is taxable ($44,000 for married filing jointly). If you are close to one of these thresholds, your financial adviser and accountant should work together to keep you in a lower bracket for taxable Social Security income.
In good times and bad, taxes are a constant—unfortunately. But careful coordination between your financial adviser and your tax professional can take some of the bite out of the process. If your investment and tax experts don’t know each other, there’s no time like the present to provide an introduction. Especially during this time of year, you need to be talking to them. But even more important, they need to be talking to each other.