Financial advisors can deploy a variety of strategies to decrease the toll that taxes can take on retiree clients’ portfolios. The following are three areas of focus.
Income: Sources and timing of income can affect tax liability.
Retirees with large taxable investment accounts should utilize qualified dividends, long-term capital gains and tax-free municipal bond income, said James A. Daniel, certified financial planner and owner of The Advisory Firm.
“For the stock side of the portfolio, the dividend income should focus on dividend paying stocks,” he said. “Either in the zero percent tax bracket, if taxable income falls below the 25 percent marginal rate, or 15 percent, if taxable income falls below the 39.6 percent marginal rate.”
For taxable gains, Daniel continued, “if the account owner limits any gains taken to those they have held longer than 12 months, the long-term capital gains tax is identical to the dividend rates above.”
Finally, Daniel advises investors use tax-free municipal bonds to balance their stock allocations with bonds in a taxable portfolio bonds.
Deferring capital gains can protect inheritances, according to Kevin Reardon, CFP and president of Shakespeare Wealth Management.
Upon death, every person receives a “step up” in basis, thereby eliminating capital gains on appreciated assets, he said.
“When someone passes away, the cost basis of an asset is raised to the market value at the time of death,” Reardon said. “For older or sickly clients, it may make sense to defer taking capital gains until they pass.
“In a recent client situation, we saved [some clients] over $100,000 in taxes for the heirs by not selling appreciated securities.”
Expenditures: Paying health-care expenses and making charitable contributions can offer beneficial tax strategies.
Those who have non-qualified annuities can use them to pay long-term care premiums, Reardon said. “Although withdrawals from annuities are taxable income, you can direct assets out of your non-qualified annuities to pay for long term care premiums and these ‘transfers’ aren’t taxable.”
Kevin Brosious, CFP, certified public accountant and president of Wealth Management, recommends that people with high-deductible health-care plans fully fund their health savings account, up to the annual limit of $6,750 per family. “The health savings account is a super IRA,” he said. “It allows the participant to contribute pretax into the plan and if the money is eventually used for medical expenses, the withdrawals are not taxed.”
Qualified charitable distributions are useful tools for reducing a client’s tax bill, said Steven Elwell, CFP and partner and vice president at Level Financial Advisors. This strategy, under certain circumstances, allows them to donate their required minimum distributions directly to charity.