Editor’s note: Join the Savvy Tax Planning School for Financial Advisors, led by Debra Taylor. School starts January 23. Learn more here.
Effective tax planning is a powerful tool that empowers your clients to retain more of their hard-earned money. By taking a proactive approach to tax planning, you can help your clients minimize their tax liability, both in the current year, and throughout their lives.
This not only saves them money but also adds significant value to your services! It also gives you the opportunity to work alongside a client’s other centers of influence, like a tax preparer or estate planning attorney.
Year-end tax planning strategies
In these final months of the year, it’s essential to proactively consider year-end tax planning strategies. While many of these strategies can be put to use throughout the year, it is important to revisit them at year-end, when the circumstances of a client’s tax situation are mostly finalized.
Following are 10 key strategies to discuss with your clients:
1. Tax diversification
Guide your clients in diversifying their investments across various account types, including pre-tax, taxable and Roth accounts. This strategy provides them with flexibility and options when it comes time to withdraw their funds in retirement. While this diversification can be accomplished through Roth conversions later in life, strategically allocating savings into the various account types in the accumulation phase can be even more effective for reducing the amount of taxes they will pay over their lifetimes.
2. Roth conversions
Explore the benefits of partial or full Roth conversions with your clients. This powerful tool can help minimize lifetime taxes and potentially maximize lifetime wealth, making it a valuable consideration for long-term financial planning. With the possibility of tax rates reverting to higher pre-Tax Cuts and Jobs Act levels should the TCJA sunset without government intervention by the end of 2025, performing Roth conversions in 2024 and 2025 presents an opportunity to take advantage of today’s more favorable tax rates.
3. Tax-loss trading and gain harvesting
While tax-loss harvesting, or even strategic gain realization, should be a year-round consideration to offset capital gains and reduce your clients’ overall tax liabilities, it’s always a good idea to give this planning strategy special attention at the end of the year.
One often overlooked consideration is that, for long-term capital gains, taxpayers can take advantage of the 0% tax rate for joint filers with taxable income below $94,050, or the 15% tax rate for joint filers with taxable income below $583,750. For joint filers, the 20% long-term capital gains rate only applies when taxable income exceeds that $583,750 level. This presents a great opportunity to systematically sell portions of large, highly appreciated, or concentrated positions in client portfolios.
4. Review client employee benefit plans
For clients who are still working, it’s always a good idea to review their employee benefit plans toward the end of the year, since open enrollment and benefit elections generally are done in the fourth quarter. Apart from the expected benefits, like 401(k)s, there could be other plans and options that the employee is not taking advantage of. More and more employers are allowing employees to make non-deductible 401(k) contributions that are converted daily to a Roth account.
For high-earning clients, deferred compensation plans might be available. While these plans do not provide a current year tax deduction, the ability to defer realization of income to the years immediately following their retirement could allow them to more evenly spread out their income and take advantage of more favorable tax rates, while also providing a stream of income for the period of time between retirement and when they start taking required minimum distributions and receiving Social Security.
5. Maximize retirement plan contributions
Encourage your clients to contribute the maximum allowable amount to their retirement plans, including catch-up contributions if they are eligible. This strategy not only helps them save for retirement but also provides valuable tax benefits in the present when making pre-tax contributions. In 2024, the limit on total employer and employee contributions is $69,000 ($76,500 with the additional catch-up contribution for individuals over the age of 50.)
Depending on the client’s situation, and the options available to them in their particular plan, it may also make sense to adjust their elections for the remainder of the year. They could consider switching to a Roth 401(k) contribution for the remainder of the year if it makes sense to build up that portion of their portfolio. Roth contributions may also make sense in a market downturn, when contributions could grow quickly as the market recovers.
6. Utilize Health Savings Accounts (HSAs)
HSAs offer triple tax benefits, making them an attractive option for tax-free growth and retirement income planning. Remember, HSAs are only available to individuals that participate in a high-deductible plan, and contributions are capped at $4,150 for an individual ($8,300 for a family). Contributions, earnings, and qualified medical expenses are all tax-free, making HSAs a valuable tool for long-term financial health and planning.
7. Distribution planning
Help your clients in developing a tax-efficient distribution strategy for their retirement savings. A detailed distribution plan should take into consideration factors such as tax brackets, required minimum distributions (RMDs), and other sources of income to minimize taxes during retirement.
A major component of distribution planning is to develop a long-term Roth conversion strategy using specialized distribution planning software. Several platforms, like Income Laboratory or Income Solver, will create optimized distribution strategies that analyze a client’s entire portfolio and create 100+ lifetime distribution strategies around the client’s specific needs and goals.
8. Appraise annuities, and consider a Qualified Longevity Annuity Contract (QLAC)
While interest rates are near the highest they have been since the 2008 financial crisis, now is a great time to consider new annuities, or review existing annuities that clients may have for potential 1031 exchange opportunities. QLACs in particular could be beneficial for individuals with large tax-deferred assets. These special contracts allow taxpayers to roll a lifetime maximum of up to $200,000 into the contract tax-free, and delay annuitization until age 85. This provides a three-fold benefit of providing a guaranteed stream of income later in life, allowing the individual to further defer distributions beyond age 73 (the age at which they need to start taking RMDs), and shrink the balance of tax-deferred assets on which RMDs are calculated.
9. Consider additional charitable giving
For clients with deductions that approach or exceed the standard deduction ($29,200 for joint filers in 2024), additional charitable giving is an excellent way to reduce their taxable income in the current year. Here is a tax-savvy way to expand this benefit: Clients can gift shares of highly appreciated securities to qualifying charities directly to avoid capital gains tax that would be incurred from selling the shares, realizing the gain, and then gifting cash. Be mindful of the limitations of gifting securities, since deductions are limited to 50% of Adjusted Gross Income (AGI), as opposed to cash contributions which can be deducted up to 60% of AGI.
For clients who are over the age of 70.5 in 2024, consider a Qualified Charitable Distribution from their traditional IRA. The limit for taking QCDs in 2024 is $105,000 per person. This can be a great way to proactively take tax-free distributions from an IRA before RMDs begin. If a client has an RMD in 2024, any amount taken as a QCD directly offsets the RMD by that same amount, helping to reduce the current year taxable income.
10. Estate planning and annual exclusion gifting
In light of the potential decrease in the lifetime exclusion for estate taxes, reviewing and updating your clients’ estate plans becomes even more critical. One strategy most clients should consider is making annual exclusion gifts to family members. In 2024, the maximum amount that can be gifted to an individual is $18,000 (married couples can double that amount to $36,000). This serves the dual purpose of reducing their estate while also providing for their children.
Here are some additional more complex estate planning strategies to consider:
Qualified Personal Residence Trust (QPRT): This trust allows the grantor to remove their primary residence or a secondary residence from their taxable estate while still retaining the right to live in the home for a specified term. QPRTs are especially beneficial in periods when interest rates are high, since the value of the initial gift of the property to the trust is discounted using the current Applicable Federal Rate (AFR). The higher the rate, the greater the discount on the value of the property.
Spousal Lifetime Access Trust (SLAT): This irrevocable trust enables couples to transfer wealth out of their taxable estates while still maintaining access to the funds for the beneficiary spouse. Clients tend to like these arrangements because of the peace of mind it provides that they will be taken care of while also trying to minimize estate taxes.
Charitable Remainder Trust: This trust allows donors to receive income for life or a specified term, after which the remaining assets pass to a designated charity. These are best used by clients of substantial wealth who are charitably inclined, or do not have children or familial beneficiaries.
Grantor Retained Annuity Trust (GRAT): This estate planning tool allows the grantor to transfer assets to a beneficiary while retaining an annuity interest in the assets for a specified term.
Conclusion
Tax planning is an indispensable service that can significantly enhance your value proposition, attract and retain high-net-worth clients, and fuel business growth. By adopting a proactive approach to tax planning, you not only help your clients optimize their financial outcomes but also position yourself as a trusted advisor.