In the home stretch of the fourth quarter of the year, financial planner Rupa Pereira of Apex, North Carolina-based FWJ Planning and Erin Wood, the senior vice president of financial planning and advanced solutions for Omaha-based Carson Group, will share the most important practice management and tax strategy tips for financial advisors, tax professionals and their clients to consider before the end of December. Financial Planning Chief Correspondent Tobias Salinger will moderate the discussion.
Transcript:
Tobias Salinger (00:15):
Hi, I am Tobias Salinger. I'm the chief correspondent at Financial Planning. Our parent company is Aris, welcome to the Leaders Forum, where we bring together innovators and senior executives to share their experiences and perspectives on the most pressing topics. The subject of our discussion today is the most important year end tax planning questions. We've got a great pair of guests today. Rupa Pereira is the founder of Apex, North Carolina based FWJ Planning. And Erin Wood is the Senior Vice President of Financial Planning and Advanced Solutions for Omaha based Carson Group. Welcome to our panelists. Thank you so much for joining us.
Rupa Pereira (01:02):
Thanks for having us. Pleasure to be here,
Tobias Salinger (01:05):
Of course. And both of you participated in our upcoming feature on this topic of the most important year-end tax planning questions. You'll be able to see that on our website@financialplanning.com early next week. One quick programming note for the audience before we jump in. Please feel free to chime in with questions at any time. I'll be sure to pose some of them to our panel as we go. And the first question, I'll start with you Rupa, but I'll ask both of you this question. From a practice management perspective, should a financial advisor set a meeting with clients for year end tax planning? Why or why not?
Rupa Pereira (01:51):
No question about Toby. So a financial plan is something that you set at the start of a year, whether it's a fiscal year or a calendar year. And since taxes play such a critical role in an overall comprehensive financial plan. So tax planning a session is definitely necessary. What I would say is at this time of the year is not so much about planning for the year that we are in. It's kind of seeing where we are versus where we started off. Has our plan gotten off the rails? Have there been variables that we didn't quite control for? Do we have time towards the end of the year to recoup any chances that we may have lost in the beginning? And more importantly, forward-looking is how could we prepare better for the year to come? It's much like how we would do it in a corporate world. They look at the year to date and they look at the year to go. I would extend the same philosophy of corporate finance to the world of personal finance. So yes, there is absolutely no question in my mind that a tax planning session is definitely necessary at this time of the year.
Tobias Salinger (03:06):
Okay. And Erin, would you agree with that?
Erin Wood (03:10):
Absolutely. I don't know that very many people in our world would say not to do it. And when you look at clients, taxes is one of the areas that clients are typically looking for help from their advisor. And advisors don't necessarily always feel real confident having those conversations. But I also think clients tend to be afraid of taxes, right? Nobody understands the tax law. It's super complex. And so doing it not only at the end of the year but throughout the year is incredibly important. And so adding that as part of your menu of services where you're at the end of the year to RU'S point, taking care of things that maybe changed that were unexpected, making sure we're taking advantage of items that we missed or we're unaware the client could actually take advantage of. But then throughout the year, making sure that we're sprinkling those conversations in and every instance makes it less fearful for the client and more likely that we're going to come up with an idea, a strategy, something that maybe would've been missed when we try to throw it all at them at one time. And so this yearend conversation is a great way to add in another touch point for the advisor to let the client know you're always thinking about 'em and to make sure we're taking advantage of any of those opportunities that we might've missed. Because if we wait till April, sometimes we lose out on something that we could have taken advantage of just a couple months previous.
Tobias Salinger (04:36):
And why don't we dive in a little bit to some of the things that advisors and clients would discuss this time of year for rupa. What are some of the most common year end issues that you usually see with 4 0 1 K contributions, IRAs and withholdings?
Rupa Pereira (04:58):
Yeah, great question. When we have this in a quarterly cadence, say we have not met with the client from the beginning of the year. They had a set contribution rate with their employer that they forgot about it. And then here we are having this discussion and then we realized that their 4 0 1 k or their 4 0 3 B, whatever employment-based retirement plan that they have access to that's not fully funded, they haven't really maximized the employer match or even the contribution limits or the cap that's available to them. So I have found that clients are not aware that this contribution goes up. The limit goes up every year and this year for those 50 and above, they can contribute 7,500 in addition to the 22,500. And that reduces not just the tax base that they would, it increases their net home pay as well as puts them in a lower tax bracket.
(05:59):
So that's the discussion I see that I have to have very often with the clients and kind of set them on a better path for the following year. As far as other, the withholdings, that's something that they would probably have filled out with their employer through their W four when they joined. And if the employer doesn't insist for an annual review of the W four, that's where it stays. But then what do you have? You have changes coming through, you have income changes, you have filing status changes, changes in the family, and then suddenly you realize, hey, my tax bill is higher. How did that happen? My employer should have been deducting my taxes. And then that's when it's a surprise, right? And it's not a very pleasant surprise. So it's just kind of letting them know, hey, if there is any income increases, then the withholdings need to be adjusted.
(06:54):
If you've gotten married or if you've had an addition to the family, then you automatically adjust your withholdings. And then when it comes to small businesses, self-employed individuals, they don't have the luxury of having an employer kind of deduct their taxes for them. So they have to make sure that they are doing their quarterly estimated payments. And I have found quite a few of those contractors that just are, they haven't chosen to become sole proprietors by choice, but they receive a 10 99 miscellaneous and it's a huge number and they don't really have any estimated payments, so at least at this time, they can make the fourth one. That date is until January 16th or 2024. But that kind of puts them in a precarious situation. They have a tax bill and then they may have an underpayment penalty as well. What I will say is the goal of withholdings should be is to not pay too much because then you have excess.
(07:55):
You are getting a bigger refund that might look good. Hey, you're getting money back from the IRS, but what you're actually getting is the money that you paid in excess or an interest free loan versus you putting that money towards a high yield savings account, which in today's world could get you four to 5% depending on whether you put it in a treasury bill or you put it in a cd. So that is not something that is not ideal either. So between withholdings, if you were to receive a bill versus receive a refund, I would lean on kind of receiving a tiny bill due that you owe the IRS as long as it's within limit within a thousand dollars so that you do not meet the other criteria for having to pay a penalty. The last thing with the IRAs is it's not the end of the world.
(08:45):
At December 31st, there are is a little bit more time to make that contribution up until April of the following year. The biggest conversation is should I or should I not put towards a Roth? Am I maxed out of a Roth because of my AGI? And then that's when the discussions is about a backdoor Roth conversion or a traditional IRA, depending on where they are in their income tax brackets. I would also like to highlight that there are a couple more opportunities that clients are not aware of on the HSA, right? The HSA also, they could contribute and that comes with the triple tax benefit and they can contribute up to April of next year. With the FSA, the flexible spending account, that's something that they, hey, they have been contributing on a monthly basis towards that, but they have no plans of using that money, and that's not something that will roll over to the next year unless the employer allows that. So it's kind of a use it or a lose it scenario. So besides the 4 0 1 Ks, the withholdings, the IRAs, I would also add to the list that there are concerns about how my clients are viewing their HSC and FSA accounts and if they're maximizing on those.
Tobias Salinger (10:03):
Wow, that was great. Really, really good strategic planning questions to go over with clients. And I'm going to turn to you now for a couple of other areas, Erin, in the realm of home improvement, just personally apologies for the mess behind me. I'm moving, but moving, it kind of gets me thinking about the whole home improvement issue, and you had brought up to me just the availability of these energy efficiency tax credits from the Inflation reduction Act, as well as another area that Rupa just touched on. Flexible savings accounts, a particular type, the Dependent Care, flexible savings accounts. What are some of the most important strategies for advisors and clients to consider over the next few weeks around dependent care, flexible savings accounts and energy efficiency tax credits?
Erin Wood (11:09):
Absolutely, thanks, Toby. This time of year is actually my favorite time of year when it comes to taxes because most clients don't think about their employee benefits as taxes, but that's exactly what it is. All of these employee benefits somehow tied back to a tax benefit or a lower income, and it's something that our clients have to do anyway. The employer sends it out and says, Hey, it's open enrollment. Come to one of our 1, 2, 3 sessions we have available and pick out your new benefits for the upcoming year. And most clients just go in and they look at the one thing, what's my health insurance option? And they go, okay, I either want the high deductible or I don't want the high deductible, but mixed in with all of this optionality at this time is those sub benefits which have huge tax benefits to the client.
(12:01):
So when you look at the HSA, the FSA, like the HSA in itself, next year goes up to 8,300 per family, so that's $8,300 non-taxable income. That right off the top is great, but then you add in something like the FSA for dependent care, and many clients overlook this one because they don't realize that it's separate from their medical. So they hear H-S-A-F-S-A, they naturally think medical, but if your employer offers an FSA for dependent care, that's $5,000 just like the HSA that comes off the top. You have no taxes whatsoever. It lowers your taxable income. And when you start layering these in combination with each other, now you're talking about to RU'S point, the 4 0 1 k, the catch up contributions, the HSA, the dependent Care FSA, and now you're going from just a few thousand dollars to 10, 15, 20, $30,000 and lowering your taxable income.
(13:02):
And that is a huge, huge benefit to people, especially for those who are on the cusp of going into a lower tax bracket. If you can use those in combination and now get yourself into a lower tax benefit, now you just doubled up on that savings, which is tremendous. Many people with the FSA dependent care, not only do they overbook it, they don't realize that it is up to 12 years old. And so that is a part that many clients miss. Their children go into kindergarten and they go, oh, I don't have daycare, so they'll just stop contributing to it. That includes things like summer care, so if you're looking at summer camps, summer care over the summers, those are great ways to look ahead. I know I do this every year with my own daughter. She doesn't go to daycare, but every year I'm looking at what camps are we looking at?
(13:50):
How much did we spend last year in camps? I'm also looking at how much did we spend for our health insurance, use your health insurance apps to look at what did you spend on deductibles? And so it takes just a second. Technology is beautiful in that way. It's a lot easier to get those numbers than they used to be, but get those now before you go into open enrollment and pick those right benefits, which goes right in combination with the other question you had on the Inflation reduction Act and energy credit. This is a great place where we talked about earlier what might be new or what is something that clients might be missing out on This energy efficient credit is a fantastic one because it has no income limits. It is a credit, so it comes again right off the top and it's very easy to get.
(14:39):
It is literally for any improvements to your home that make it more energy efficient. So think doors, windows, heating, air conditioning, all of those are very easy to do. Updates to our house, and this is a multi-year credit. It's new this year. So many people have overlooked it. It is literally you get a new door that's more energy efficient, keep that receipt and you get to turn it in. So the maximum credit is $1,200 for the year up to 30%. So $1,200 for most home improvements is where you're going to get capped. Home improvements tend to be expensive, but when you're looking at remodeling a home, refurbishing a home right about now is that time I'd be looking at if I have a project going on, maybe I want to start that project November, December, put some of those expenses in then and then finish the project in January or February, make sure I take advantage of that credit for two years.
(15:32):
In addition to the credit, there is a higher amount for things like solar panels on roofs, geothermal that does go up to 3,200 for those types of improvements. But the other part on this that isn't necessarily about your federal taxes or state taxes, make sure you're looking at your states too. In addition to the federal credit, there are rebates available that are given at the state level. So there are two different rebates programs available. You do have to go to each state because they're different for the states, but definitely go look at those as well because getting that added on is again, just another way we can do doubling up on some big saving opportunities.
Tobias Salinger (16:16):
Excellent. And I'm going to come back to you, Erin with our next strategic question and something that is a big subject around this time of year that a lot of tax professionals and financial advisors talked about with me in compiling this feature this year, and that's capital gains. It's always an important taxable event and tax loss harvesting could be a helpful tool. Erin, how can advisors in their clients assess the best method of timing the gains and pairing them with losses in order to find the biggest potential savings?
Erin Wood (17:04):
So I always look at this from a holistic approach. When I'm working with clients as a financial planner first I'm always looking at the overall asset allocation of course, and making sure that we are rebalancing on a normal basis to take advantage of those gains and losses so that we're not losing those opportunities. But I think with this one, what I find more often is this is a behavioral coaching potential. Many clients become very attached to certain stocks, especially if they've inherited them or their company stocks. And so getting them to sell it is more of a behavioral coaching than it is an actual timing of it. And so with them, I'm always looking at how does this tie into their overall portfolio and starting to move clients more towards the resources that are available today. One of the greatest things that's happened over the last couple of years is many of the custodians are looking at how do we have accounts that will automatically do this for you?
(18:02):
And if you can get those accounts that are always doing the rebalancing for you, their tax cost harvesting, that becomes something now that we've taken it really out of the hands of the clients in the behavioral approach and it's been automatic to the account. And so those have been my best tools for doing this is to make sure that for the clients, that it is a specific stock that's near and dear to their heart that we are having those behavioral conversations before it becomes an issue. Now of course, that sounds great. Clients typically come to us when it's already an issue. So I know that sounds a little like I'm just waving the magic wand, but I start talking about it always before it comes to that point and then trying to get people to move more into the tools and resources that are available, so it makes it automatic.
Tobias Salinger (18:49):
That's great, and I'm glad you brought up the behavioral side. It kind of reminds me of a story from this past weekend. I was hanging out with some friends and somehow the topic of bonds came up and this couple had some bonds and one wanted to sell the bonds and the other didn't, and it was actually a very emotional subject. I don't even know how we got on bonds in the first place, but I was a little bit sorry that I brought it up because there was a lot of tension around the potential selling of these bonds out of their portfolio. But always interesting to bring in the behavioral side of planning. Rupa for you the same question. How can advisors and their clients kind of figure out the best method of timing these gains and pairing them with losses?
Rupa Pereira (19:47):
Yeah, I would piggyback on what Erin said that it has to be looked at as an overall asset allocation kind of a choice. Yes, it is a tool, but it is not something that you use just to maximize on the gain on your tax return for the upcoming tax year. But holistically, is that a position that if you were to lose, you are okay with? Right. Sometimes we take investment choices very personally and if there is a position that is loss making, it really affects us. But what I would say is, hey, when you have lemons, that's the time you make lemonade. It's not a completely lost situation. You can actually get some returns. What you could do is you could offset some of the other gains you may have made out of exiting some other positions and then that offsets that. And if you don't have that this year, you can shelter future gains and that's what you're harvesting.
(20:41):
You're harvesting your losses for future years. That way you could shelter not just your gains, you could also shelter up to 3000 of your ordinary income. So it'll result in a lower tax bracket this year, and if not, it will save you. It's a shelter for future years. And the way I would look at it is it's not completely avoidance of taxes. It's like you may have to pay it at the later point you you're redeploying the capital by exiting that position into a security, into an asset that might be more in line with your current asset allocation principles, your investment objectives, that way you could generate a higher return. So I would say a tax loss harvesting does need to be looked at from an overall perspective, yes, at the end of the year, and you have until December 31st, and I think December 31st is a trading day.
(21:37):
So I remember personally, there were a couple of stocks that I had initially invested in and it felt very, it hurt me that what happened, how come I made such poor investment choices, but then I hit the sell button and boom, it helped me with my tax return the following year. So I would say tax loss harvesting can be used as a tool. It's something that the investment advisor needs to kind of have that discussion gently with the client saying that, do you anticipate getting back into the security? If you do, then we need to make sure that we don't violate the wash sale rule. So there are a few considerations out there, or is there another liquidity event that you want to offset based on exiting this position? That's another consideration because there has been a short-term gain given the high volatility this year, and they're trying to get that short-term gain onto their taxes that gets taxed at a higher rate than a long-term gain.
(22:37):
So that's a good time to look at tax loss harvesting and then sheltering that gain. The other thing I would also like to mention is there is tax gain harvesting also. It's suppose there's somebody who potentially could be at a higher tax bracket in the future, in the near future that would tax their capital gains at 20% versus 15%. They could probably take some gains off the table this year, getting them taxed at a lower rate and then getting back into that position, that security at a higher cost basis, and then that way they will save on a future textbook.
Tobias Salinger (23:17):
Excellent. And to point it back to you again, Rupa, another big area all times a year, but especially right now is charitable donations. What are the most important strategic questions this time of year around maximizing impact from both a giving and a tax savings point of view?
Rupa Pereira (23:50):
Yeah, for a couple of years, Toby, we could take a small charitable deduction about the line charitable deduction, and that's gone. So the only way they could be a tax benefit by donating charitably to a nonprofit that aligns with your cause is when you itemize. And given that we have such generous standard deductions, it needs to make sense to find out, Hey, by me making a charitable deduction combined with my other itemized deductions, would it exceed my standard deduction bracket? What I would suggest is, and I think quite a few of the financial experts have spoken about this, it's called the bunching strategy, is if you anticipate planned medical expenses or you have a mortgage coming up, you buying a home, or you have property taxes and then you also would like to contribute to a charity, then you could consider alternating such a way that you have enough charitable contributions that would bump you over the limit of a standard deduction based on your filing status.
(25:02):
That way you do see, you see some tax benefit out of donating to a charity. It does have to be a qualified charity to get up to 60% of an AGI contribution limit of 5 0 1 C three. The other aspect of donating to a charity is giving highly appreciated securities that way the capital gains do not show up on your tax return. The non-for-profit gets a full benefit of your sale, and it's completely given at fair market value. So that's another way to donate charitably to an organization that you support. Then what I would also say is for retirees who have already approached 17 and a half and they really don't want to make the RMD distribution, they can contribute up to a hundred thousand per year towards a charity through a qualified charitable distribution, AQCD that keeps the gross income. It doesn't show up in their gross income, plus it gets donated to a charity. And I have found that quite a few retirees were not even aware of this, so they were contributing to a charity in huge amounts, and they didn't see that showing up in their tax return. And when it was suggested to them that, Hey, you could also do it this way, they're like, oh, my financial advisor did not mention that to me and I was their tax professional. So there you go. Sometimes the tax professional needs to provide financial advice as well.
Tobias Salinger (26:48):
Excellent. And Erin, same question to you. If itemization is potentially in play or there are other situations where charitable contribution could be beneficial from a tax perspective in addition to the impact of the giving, what are the most important questions to go over with clients?
Erin Wood (27:12):
I completely agree with everything Rupa said so far. I'm a big fan of the bundling bunching. You're itemized into those specific years and looking at all of the things she said in combination of each other, this is the same thing we were talking about before where all of them are great individually, but you might not be able to take advantage of all of them at one time. And so looking at that place of, if I can take advantage of a huge deduction today, well, you may not want to distribute that all today. That's one of the biggest hurdles I hear when talking to clients is, well, I'll give a bunch of charity, but I don't, what if I'm not going to give, again, another three years, four years, five years, putting that money into a daf. A donor advised fund is a great way to take that deduction right up front so you can take advantage of that bundling and then distribute those funds over multiple years.
(28:03):
I happen to be in the Midwest, and so in addition to us talking about cash in stock, you can give a lot of other items to DAF as well if you can actually give cows. So some DAF will actually take physical cows and you can get a deduction on live assets. They'll take farm ground, they will take business sales so they can be part of if you're exiting a business, all great ways to look at those in addition to those business sales, great examples, big years, you're getting bonuses. You might want to look at some trust in this area too. Charitable lead trust, charitable remainder trust, great way to be able to put those needs of your family in place, get some income for yourself, and then also make a very large charitable contribution. One area to hit, especially for those over 70 and a half, I see this come up frequently. A lot individuals who are giving to their church, typically those churches are going to qualify for qds. So even for those individuals who maybe don't have a charity that they say is near and dear to their heart, but they are regular church fillers and give ting, looking at those qds is a great way for those individuals to be able to continue doing that and take advantage of that as well.
Tobias Salinger (29:19):
Well, I think it's a great note to end on. We're just out of time, but everyone please give another virtual round of applause to our guests, Rupa Pereira of FW J Planning, and Erin Wood of Carson Group, and don't forget to check financial planning.com next week for the end of the year tax feature and all of FPS Wealth Management News. If you want, go ahead and subscribe while you're there for financial planning. I'm Tobias Salinger. Thanks again to our panelists and everyone, have a great afternoon.
