7 Questions Investors Should Ask Their Advisors

A Financial Advisor Sitting And Talking With A Client About Financial Planning

As published on Paladin Registry

As we approach April 15, it is quite possible taxes are on investors’ minds. If you are working with a fee-only or fee-based financial advisor, there is a good chance that he or she will have a good understanding of the individual tax rules that are relevant to investors. If they do not know the answers, they should certainly know where (or from whom) they can get them. Make sure you ask a tax expert before making any big decisions.

The year 2017 is now in the rearview mirror. There are not that many things we can do to impact our tax liability for last year. As a result, most of these questions will relate to 2018 and beyond.

Near the end of 2017, some long-anticipated changes to the tax system were passed. As far as the 2017 Tax Act is concerned, the discussion will focus on those changes that are most closely related to our investments and/or our financial plans. Some other relevant items have been included as well. Here are some relevant questions – and the answers:

1. How do the changes to the tax law effect Roth IRA accounts?

The new tax rules lowered tax rates; however, unless further changes are enacted, rates are supposed to return to their prior higher levels in 2026. It is possible that they will be even higher in the future. If you believe that rates will increase, the new tax law enhances the attractiveness of such accounts to retirement savers who would like to boost their nest egg. While Roth IRAs are funded with after-tax funds, the lower rates make contributions more attractive, as the cost of contributing will be lower. The amounts in these accounts will still be able to grow tax free. Perhaps most importantly, when you withdraw these funds, you will be able to do so tax free, and rates could easily be higher in the future than they are today.

2. Will my charitable contributions still be deductible under the new law?

After the changes to the tax law, it will be harder for taxpayers to itemize their deductions. This will also make it harder to deduct your charitable contributions. However, there are a couple of things you can do to optimize the tax efficiency of such contributions.

  • Combine several years of donations together and make a few years of charitable contributions in a single year. This may help increase your total itemized deductions over the threshold of $12,000 for single filers and $24,000 for those filing joint returns. Remember to write your checks in the year you want to take the deduction.
  • Create a Donor Advised Fund. This will allow you to make larger deductions in a single year that you can parcel out in the future. Once you have put the money in the fund, you can advise – not direct – the charitable organization on how your contributions will be distributed to other charities.
  • Donate appreciated stock rather than cash.This will allow you to avoid paying capital gains taxes on your gains too.
  • Make a charitable donation directly from your retirement account. If you are 70-½ or older, making a qualified charitable contribution directly from an Individual Retirement Account (IRA) – not a 401(k) – to a qualified charity provides a more tax-efficient method of philanthropic giving than withdrawing the money from the IRA and then donating it. Such contributions count toward your Required Minimum Distribution (RMD) for the year. While they do not give rise to a charitable contribution, they do not get reported as income either. Using this strategy can also help limit the amount of your taxable Social Security benefits.

3. Does it matter what time of year I withdraw any RMD amounts?

RMDs are due by year end. Conventional thinking says that, especially if the market is performing well, waiting to take them late in the year maximizes the tax deferral associated with such amounts. However, if you take your RMDs earlier in the year, it will put less pressure on your beneficiaries. If you pass away late in the year, it can be difficult for your beneficiaries to take the distribution. If an IRA owner dies before year end, the beneficiary must take the RMD that the deceased IRA owner would have been required to take if he or she had lived. If there is not enough time to take the RMD by year end, the beneficiaries will be required to file IRS Form 5329 – Additional Taxes on Qualified Plans (including IRAs) and other Tax Favored
Accounts – for the year of death. This form is used to request a waiver of the penalty that will be incurred when a RMD is not taken by the beneficiaries in the year of death.

In addition, once an individual is subject to the RMD rules, under the tax law, the first dollars of the year that are withdrawn from the IRA are deemed to satisfy the RMD. This can impact your ability to rollover the RMD to another account. You are not allowed to convert RMDs into Roth IRAs, as they are treated as rollovers and RMDs cannot be rolled over.

4. My company offers a Health Savings Account (HSA). Should I contribute to it? If I contribute, should I use it to pay for current expenses, or is it better to save it for the future?

If they even contribute at all, most people do not take advantage of the full benefits of a health savings account. Instead, they use it more as a checking account rather than as the investment vehicle it could be. Generally, HSAs allow individuals to make tax-deductible contributions into a custodial account. The amounts in such accounts can grow tax-free. The money can also be withdrawn tax-free if it is used to pay for qualified healthcare costs. In short, they can provide a triple tax benefit:

  • Contributions are tax free;
  • Amounts in the account can grow tax-free; and
  • Amounts can be withdrawn from the account tax-free

In contrast to flex spending accounts, where amounts contributed that are not used in the current year are lost, contributions to an HSA are not “use it or lose it.” So, instead of reimbursing yourself for out-of-pocket healthcare expenses today, you can pay with taxable dollars today. If you keep a record of your expenditures, you can reimburse yourself at any time, even decades later. If you are interested in learning more about HSAs, you can read this post.

5. Are there any changes to how I should pay any investment fees because of the changes to the tax law?

Under prior tax law, investment expenses were treated as miscellaneous deductions that were deductible to the extent they exceeded 2 percent of your adjusted gross income. Miscellaneous deductions from AGI have been eliminated for the tax years from 2018 to 2025 (the changes to the tax law for individuals are currently only applicable through 2025). This means such amounts are no longer deductible. As a result, it can be advantageous to have such fees paid directly from retirement accounts, meaning the amounts used to pay such fees are essentially tax-free.

6. If I have retirement savings in tax-deferred accounts such as IRAs as well as taxable accounts, does it matter which assets are held in which account?

Asset location is an important element of an effective financial plan. The concept refers to placing investments in taxable accounts or tax-deferred accounts based on the taxability of the investment. For example, if you own high-yield bonds or bond funds and do not have a current need for the income, it may be best to hold them in your tax-deferred accounts. For a more detailed discussion of asset location, please review this post.

7. What are some ways I can proactively manage the tax rate associated with my portfolio both now and in the future?

If you think ahead, there may be ways you can lower your tax bill in your retirement years. For example, you can convert some of your IRA balances into Roth IRAs. While there may be a current tax cost associated with a Roth conversion, if your current tax rate is lower than your future tax rate, a Roth conversion can be beneficial. It can also reduce your taxable income in the future, possibly limiting the amount of tax you pay on your Social Security benefits. It can also limit the size of your future RMDs, which can further benefit your tax rate.

Taxes can materially impact the size of your nest egg. A well-constructed financial plan takes taxes into account. The above list represents some of the topics you might want to discuss with your financial advisor. They represent some of the ways you can increase the tax efficiency of your portfolio and minimize the amount of taxes you pay. Again, make sure you ask a tax expert before you make any changes to your plan.

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