Each December, consumer magazines and newspapers swell with year-end tax planning tips. Unfortunately, such advice comes too late in the year for most people to act effectively. What's worse, the last-minute sell-off it often inspires can wreak havoc on an investor's long-term financial plan. Ideally, portfolios should be managed for tax advantages all year long, but since few investors are inclined towards such sustained attentiveness, the responsibility often falls squarely on the shoulders of the financial advisor.
This year is likely to present a huge number of challenges — and opportunities — to advisors. For starters, tax laws are likely to be overhauled. With a Republican majority in the House and Senate and the nomination of John Snow for the treasury secretary post vacated by Paul O'Neill, tax cuts have become a front-burner issue. Looming large among the tax-reduction proposals is the elimination of personal income taxes on corporate dividends.
Though it's unclear how this and other proposals will fare as the year rolls on, there are a number of planning opportunities advisors should consider exploiting now, specifically ones in the following three.
Personal Income-Tax Strategies
Given the depth and breadth of the market's decline, it's possible you have clients with equity holdings that now have the dubious distinction of being penny stocks. Rather than holding these securities in the faint hope they'll experience a revival, conduct some general portfolio housecleaning and capture the subsequent losses for 2003 or future-year tax returns.
With low interest rates, it's prudent to review your clients' debt with an eye toward consolidating liabilities and taking advantage of favorable rates. Such consolidation can aid in tracking tax-deductible interest payments to ensure that they don't fall through the cracks. Also, look for ways to convert non-deductible interest into a deductible expense. For example, pay off credit card debt with a home equity loan.
Finally, if you have clients who are looking for a new job, be sure that they retain receipts related to their search. These expenses might be deductible.
Estate and Gift Tax Strategies
Encourage clients to make gifts early in the year. That way, the appreciation that could occur during the year is transferred without any gift tax implications.
For example, have grandparents make tuition and medical expense payments directly to the institution. Or have them give annual exclusion gifts directly to grandchildren or perhaps to their 529 plans. Lump-sum contributions to 529s can be made in amounts up to $55,000 ($110,000 for couples filing joint-tax returns); this money can be exempt from the gift tax, provided no subsequent gifts are made during the next five years.
Finally, consider more sophisticated estate-planning strategies that allow your client to transfer wealth with minimal or no gift taxes. These include grantor retained annuity trusts, charitable lead annuity trusts and intentionally defective grantor trusts. Given the prolonged equity market decline and low interest rate environment, the timing is quite favorable for these types of transactions.
Retirement Tax-Planning Strategies
In terms of retirement planning, there are a number of ways you can help your clients from an investment opportunity/tax deduction standpoint. Be sure that they're maximizing their contributions to 401(k) plans to take advantage of tax-deferred compounding, company-matching contributions and catch-up provisions.
The same applies to tax-deferred IRAs. Be sure clients over 50 know they can make a $500 annual “catch-up” contribution to their IRA, and urge clients to make annual contributions early in the year rather than on April 15th of the following year. By doing so, they can maximize their tax-deferred growth potential. Finally, explain the benefits of consolidating retirement accounts and rollover IRAs whenever possible to avoid fragmentation issues.
Building the Full-Service Relationship
It's helpful to schedule a “checkup” with each client early in the year. Such meetings give you a chance to discuss and implement strategy while affording you the opportunity to review the client's financial and estate planning paperwork. Ensure that your clients have up-to-date beneficiary designations, healthcare proxies, wills and trusts, etc. This helps avoid unwelcome surprises down the road, and it might even uncover some “hidden assets.”
By taking a proactive approach with your clients' investments and tax implications today, you will demonstrate the value you add as their financial advisor and help strengthen your client relationships in the years to come.
Susan L. Hirshman is vice president at JPMorgan Fleming Asset Management.