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Between now and April 15th, everyone’s mind is getting their personal income tax return filed. If you are a financial advisor, clients are depending on your firm to provide 1099 information in a timely manner. No one wants to be told "You owe the government money." If a client asks “What can I do to pay less in taxes next year” what can you tell them?
No doctor would prescribe treatment or a drug without first learning about your condition. Your first step must be to learn about your client’s financial situation and how their actions led to owing the government money. Let us assume you have done that already.
1. Get a good accountant. A little knowledge can be dangerous. Your client might have an idea or two. Hopefully they are legal. As their financial advisor, you see the bigger picture, but accounting is not your profession. Suggest they hire a professional to help them prepare their taxes. They want a face to face local relationship. This costs money, but it is money well spent.
2. Maximize the contributions to your retirement plan. The dollars you are allowed to contribute to your retirement plan at work or setup through a financial services firm lowers your taxable income by a corresponding amount. Put another way, $1,000 directed into your 401(k) at work reduces your taxable income by $1,000.
3. Make your retirement plan contributions as early as possible. Suppose you have an IRA account. You are not putting money aside every month, you are simply moving it from (taxable) savings into tax deferred savings (or investment). The money earned through the remainder of the years grows in a tax deferred, not a taxable environment.
4. Strive to earn long term, not short term capital gains. Trading stocks can be fun. It can also be expensive when your silent partner, the US Government, shows up to claim their share. If short term gains are taxed as ordinary income, your trading profits are treated like a raise at work for tax purposes. The tax rate on long term gains is 15% or 20%, depending on your income. If those gains are long term, the tax bite is smaller.
5. Can your short-term debt be consolidated within your Home Equity Line of Credit? Credit card interest does not qualify as a tax deduction. It did once, in the distant past, but not today. The government allows HELOC interest as a tax deduction if the funds were used for home improvements. If you have added an addition, bought new appliances or remodeled your kitchen, that debt should not be on your credit card. If it is on your HELOC, it should qualify as a tax deduction.
6. Do you have ongoing medical expenses? A Health Savings Account (HSA) may be a way to earn interest that isn’t taxed and qualify for a tax deduction to reduce your income. You put money into the HAS. You qualify for a deduction to reduce your taxable income. You spend the money when the medical bills come in. You hope you won’t have ongoing medical bills, but the government lets you reduce your taxable income if you do.
7. If you are eligible to collect Social Security, but don’t need it, leave it there. Social Security income can be taxed. This contributes to your taxable income. You might still be working or have sufficient income from other sources not to need the extra cash. The size of your future payments also grows when you defer colling Social Security.
8. Are you subject to Required Minimum Distributions? The government let you reduce your taxable income through retirement plan contributions for decades. There comes a time when they want their share. When you turn 73 (or retire, depending on the plan) the government wants you taking distributions according to a formula. The money comes out. It raises your taxable income and you pay taxes. If you don’t need the money, giving to a recognized charity through a Qualified Charitable Distribution (QCD). There are limits. Designating QCDs can take this additional boost to your income out of the picture.
9. Earn tax exempt income. Municipal bonds were popular in the 1980’s when interest rates were in the double digits. Since rates have risen in the last few years, people with lots of money in bank savings may see the taxes on they earned interest causing a problem. State and local governments issue tax exempt bonds at both short and long maturities. If they don’t need access to the money anytime soon, this might be an option.
10. Have you heard about Securities Based Lines of Credit? (SBLOC) This is similar to a margin interest loan because it is secured by the underlying stocks in a portfolio. Unlike credit card interest, the SBLOC interest charged might be tax deductible. You need to talk with your tax advisor to learn more. This may be a more tax efficient option for short term borrowing needs.
There are ways to lower your taxable income, but you need to be proactive. Plan in advance. You need a qualified tax professional on your team to show you how.