Brooke’s Note: This is a good and timely column. It has findings of a well-researched study and a very handy cheat sheet for advisors who want to be reminded of several of the tax-related thoughts they can bring to clients relating to 2013’s fathomable changes.
If you’re like me, you’re probably a little relieved that the presidential election is over. It’s nice to be able to watch TV again without being bombarded with political ads. You may be pleased or disappointed with the outcome of the election, but regardless of personal politics, we have one thing we didn’t have a few weeks ago: more clarity.
One issue in particular that has come into better focus is taxes. For anyone who was still unclear about the future of our country’s tax code, our newly re-elected president recently affirmed what he promised on the campaign trail — he is going to look for revenue to address the budget challenge through new taxes on the wealthy. See: Here’s a 15-item checklist of low-hanging tax tips for financial advisors.
Obviously this presents a new challenge for mass-affluent investors. The good news is that the financial service industry can help them understand options to prepare their portfolios for these changes. At Nationwide Financial, we were curious about how mass-affluent investors planned to adjust to this new reality, so we commissioned a survey of 751 investors with $250,000 or more in annual household income or investible assets to ask them what they expect to happen with taxes and what they plan to do to their personal portfolios as a result. See: Why brokers from Nationwide, LPL, Merrill Lynch and others are giving RIAs a cut of their 401(k) action.
New tax reality
Not surprisingly, most survey respondents (63%) are concerned that their investment portfolios will be negatively affected by tax code changes now that President Barack Obama has been re-elected. However, it was a bit of a surprise to learn that many of them don’t plan to do much about it. See: Fiscal Cliff is ready for his close-up — whether we are or not.
Nearly two-thirds (64%) don’t believe it’s possible to make adjustments to help offset pending tax increases, and probably as a result of this thinking, 60% of respondents say they either won’t — or are unsure if they will — meet with a financial advisor to discuss how these changes may affect their portfolio.
Seventy-five percent think Bush-era tax cuts will be completely eliminated or at least reduced (33%) for the wealthiest Americans. Despite this concern, 61% will take no action, saying they either don’t plan to make adjustments to their portfolio or don’t know what adjustments to make.
Our survey sheds light on a significant opportunity for advisors to proactively engage clients in a discussion about how tax code changes may impact their portfolio. While most financial advisors don’t give tax advice, they can provide portfolio advice based on the new tax reality. But if advisors don’t convince their clients to have this critical conversation now, they may miss out on significant opportunities that could expire as soon as the end of this year. According to our survey, most investors are not planning to initiate this discussion.
The survey did provide some good news. While only 1 in 10 respondents have already met with their advisor, nearly all of those who did found it to be helpful in understanding tax code changes and planning changes to their portfolio that will minimize potential impact.
It’s clear that clients who are having these conversations with advisors are glad they did. This type of proactive counsel is a great opportunity for advisors to build trust and cement long-term relationships, and may lead to some great sales opportunities.
The survey also sheds light on an opportunity for advisors to help clients understand how tax-advantaged products may enhance their portfolio. Forty-one percent of respondents want more education on the potential advantages of annuities. Others want more education on the potential advantages of life insurance (21%) and 401(k) plans (25%). See: What a wave of 401(k) lawsuits tell us about what RIAs really need to worry about.
Another opportunity for advisors who can move quickly involves legacy planning. Although the gift and estate tax exemptions are scheduled to shrink from $5.12 million per person ($10.24 million per couple) to $1 million at the end of the year, 59% of respondents say they are unaware of these changes and 60% say they do not understand very much or at all how a life insurance policy can help them take advantage of the current gift tax exemption. Forty-three percent would like more education on that topic.
Make the call
A good rule of thumb for advisors to keep in mind as they work with clients is to seek opportunities for tax diversification — that is, make sure the portfolio has items that are taxable now, taxable later and tax-advantaged.
Here are a few other potential opportunities for advisors to discuss with clients:
• Consider harvesting gains to take advantage of current capital gains rates.
• Consider converting funds or investments that are currently taxable into tax-deferred vehicles.
• Pay special attention to dividend-paying stocks.
• Consider shifting income into 2012 to take advantage of lower rates.
• Consider funding a Roth 401(k) or Roth individual retirement account.
• Consider converting traditional IRA assets to a Roth IRA.
• When 2013 arrives, consider maximizing deductible retirement plan contributions.
• Consider shifting assets in taxable accounts to a deferred variable annuity.
So now we know two things that were unclear just a few weeks ago: Taxes are likely to increase for the affluent and many affluent investors are planning to passively watch what happens to their portfolio as a result. Now is the time for financial advisors to pick up the phone to invite their clients to have a critical discussion about their portfolio. This simple action is an outstanding opportunity to demonstrate value as a proactive counselor and long-term partner. Don’t wait for the phone to ring, because it may not.
Eric Henderson, FSA, MAAA is senior vice president of annuities and life insurance for Nationwide Financial. Nationwide does not provide tax advice. Tax advice should be sought from a tax professional such as a certified public accountant. All survey stats represented in this article come from Nationwide Financial’s 2012 Tax Survey. There may be tax liabilities or fees associated with converting a traditional IRA to a Roth IRA.