April 15th is fast approaching. Now more than ever, it’s the right time to talk taxes.
For many clients, taxes can be the single biggest investment expense they will face, particularly the high net worth—with rates as high as 40 or even 50 percent every year when federal and state taxes are combined.
But there are solutions to help clients reduce taxable income and minimize the impact of taxes on investment gains. Start with tax deferral. A strategic use of tax deferral can generate additional tax-alpha of 100 bps or more—without increasing risk— to help clients build more wealth.
Max Out Tax-Deferred Qualified Plans:
Clients should take full advantage of tax-deferred qualified plans. By contributing pre-tax dollars, clients can reduce their taxable income now, accumulate more through years of tax-deferred compounding, and pay taxes in retirement—when they are likely to be in a lower tax bracket.
Start with employer sponsored plans such as 401(k)s—especially if there is an employer match. For the self-employed, common tax-deferred qualified plans are Simplified Employee Pension Plans (SEP IRAs), Savings Incentive Match Plan for Employees (SIMPLE IRA), and individual 401(k)s. Once workplace plans are maxed out, clients can make contributions using pre-tax dollars to Traditional IRAs and after tax dollars to Roth IRAs.
The 2015 contribution limit for workplace plans such as 401(k)s and 403(b)s is $18,000, up from $17,500 in 2014. The catch-up contribution limit for participants ages 50 and older is $6,000, up from $5,000. The 2015 contribution limit for traditional IRAs and Roth IRAs is $5,500, with catch-up contribution limit of $1,000. Contributions to workplace plans must be made before December 31 of the specific tax year. Contributions to Traditional and Roth IRAs can be made until the April 15 filing deadline.
Leverage Low-Cost No-Load IOVAs:
High net worth and high earners can quickly max out the contribution limits of their qualified plans and need other options for more tax-deferral. But many advisors overlook traditional tax-deferred variable annuities, because of high costs, steep commissions and limited fund choices.
Now a new generation of Investment-Only Variable Annuities (IOVAs) has been built to maximize tax deferral and fit the fee-only model. Designed as a true tax-advantaged investing platform—instead of a costly and complex insurance product—this new category of IOVAs features low costs, no commission, and more funds. Effectively, IOVAs can be used as a “401(k) Extender” to help your clients minimize taxes over the long term and maximize tax-deferred accumulation.
Asset Location for Alternative Strategies:
To manage volatility, mitigate risks and potentially generate more alpha, many advisors use non-correlated assets such as liquid alternatives. But these can be tax-inefficient due to high turnover and short term capital gains. Using asset location—to “locate” tax-inefficient assets in a tax-deferred vehicle like a qualified plan or a low-cost IOVA—can preserve all of the upside without the drag of taxes. For investors heavily allocated to fixed-income, commodities and REITS—typically taxed at higher ordinary income rates—asset location can have a measurable impact as well.
Other tax-planning strategies to implement now and throughout the year include:
Clients can harvest losses to offset investment gains and lower their tax liability. Focus on rebalancing their portfolio or selling investments that no longer fit their goals. Don’t sell with the intention of buying shares back right away. The IRS “wash sale” rule bars investors from claiming the loss if they buy the same or a “substantially identical” investment within 30 days of the sale.
Annual Gift Tax Exemption
An individual client can gift of up to $14,000 per year—and couples can gift of up to $28,000 per year—to an unlimited number of recipients. These gifts help reduce the taxable estate—and are exempt from federal gift taxes. Gifts may include cash, stocks, bonds, and real estate. To contribute toward a child’s education, payments made directly to an educational institution typically incur no gift tax. To fund education also consider a tax-deferred 529 plan.
Even small contributions add up. Clients should track all donations, and must receive proof for donations of $250 or more. When making a significant gift to charity, consider appreciated stocks or mutual fund shares that clients have owned for more than one year. The deduction is the fair-market value of the securities on the date of the gift—not the amount the client originally paid for the asset. Boost tax returns by deducting the appreciated amount—while never paying taxes on the profit.
Talk Taxes Now—and All Year
Taxes may be one of the biggest investment expenses that your clients face. By using the power of tax deferral, leveraging the benefits of low-cost Investment-Only VAs, and taking a more strategic approach to managing taxes with asset location, you can help clients minimize taxes, optimize their portfolio and build more wealth. The advantages are clear. So talk taxes now—and all year long.
Learn more about Jefferson National here.
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