Five Retirement Tax Tips to Show Your Value as an Advisor

Whether through investing in tax-efficient savings vehicles or managing withdrawals to limit Uncle Sam's take, helping clients minimize the tax burden on their investments is one way to help them realize their best returns. By reducing your clients' taxes in retirement, you can show your value as an advisor.

As noted in our 2023 Retirement Market Outlook, we asked retirees and active workers what financial advice they consider very valuable. Retirees named investment selection and asset allocation/rebalancing as their top two, followed by retirement planning and tax planning. By contrast, active workers most often saw value in paying for retirement planning and tax planning, followed by investment selection and asset allocation/rebalancing.

Are your clients making the best use of tax-advantaged vehicles? Consider the following two scenarios:

In the first scenario, $10,000 is invested in a tax-deferred account and $10,000 in a taxable account. All gains are taxed at the capital gains rate at the end of 30 years (rather than each year). The investor’s marginal tax rate doesn’t change in retirement.  

In scenario two, half of the taxable account’s gains are taxed each year, and the investor drops one tax bracket in retirement. This hypothetical situation shows an even greater gap between the net returns of tax-deferred and taxable accounts. (Note that while these graphics focus on tax-deferred accounts, Roth accounts are also tax-advantaged and may be preferable in certain situations.)

You can add value to portfolios with tax-loss harvesting. It is especially important to offset short-term capital gains and their higher tax rates with longer-term gains, as well as to defer long-term capital gains for as long as possible. Financial professionals should be mindful of the wash sale rule when engaging in tax-loss harvesting: The IRS will disallow a loss if the same security or a substantially similar one is repurchased within 30 days of the sale.

The importance of strategically realizing capital gains and losses is an opportunity for you to pitch clients on consolidating their assets. It's not uncommon for someone to have funds with multiple advisors, which unfortunately reduces each professional's visibility into an individual's capital gains and losses. Highlighting the advantages of full visibility can give you a shot at growing your business with existing clients.

Charitable giving can be a powerful way for investors to support causes they care about and reduce their tax burden simultaneously. Donating appreciated securities to a registered charity and qualified charitable distributions from an IRA are two techniques that may be worth exploring with your clients.

In addition, you may wish to suggest that some individuals gift securities through a donor-advised fund. By doing so, an investor would:

• Receive a charitable tax deduction for the fair market value of the contributed asset, subject to IRS limits
• Avoid capital gains taxes on appreciated long-term securities
• Enjoy tax-free potential growth of contributions invested in the fund, which can fuel future giving

Converting a traditional IRA into a Roth IRA may make sense for some investors. This move is most compelling when someone pays tax on the conversion at a fairly low rate. Roth conversions are especially beneficial for those who:

• Have an unusually low income
• Plan to leave assets to heirs who will have a high tax rate
• Want a hedge against higher statutory tax rates
• Don't need required minimum distributions to meet retirement expenses

Conventional wisdom says that investors needing funds should consider a taxable account first, a tax-deferred account second, and a tax-exempt (Roth) account last. However, this may not be a one-size-fits-all solution.

Here are four strategies that, depending on the individual circumstances, might be preferable:

1. Take advantage of low tax rates in retirement. For retirees in a low tax bracket, an optimal approach is to spread out withdrawals from a tax-deferred account, paying little to no tax in the process.

2. Consider using untaxed capital gains. Investors early on in their retirement may be able to take advantage of capital gains below the threshold for paying tax. Compared with ordinary income, the tax threshold for capital gains is much higher.

3. Consider heirs’ tax situations to help prioritize tax-deferred or Roth distributions. If someone’s heirs have a high marginal rate, leaving them Roth assets can be advisable. Alternatively, if the heirs have a low marginal rate, the individual in question may wish to leave them tax-deferred assets instead (and draw down the Roth assets themself).

4. Use the step-up in basis provision to leave assets as part of an estate. The higher percentage of appreciated assets someone has, the more it can make sense to leave those to their heirs, who can take advantage of the step-up in basis.

A skillful tax approach—yielding higher net returns—can be the difference between a good or great retirement for your clients. For additional insights on tax consequences and withdrawal strategies, read our white paper, How to Make Your Retirement Account Withdrawals Work Best for You.