Let’s talk: How to have tax conversations as an advisor in 2023

There are many conversations a good advisor will have with their clients on a regular basis. Conversations about lifestyle and goals, conversations about family and work, conversations about values and purpose – and, of course, lots and lots of conversations about markets, returns, and dollars and cents. 

So it might seem like a lot to ask advisors to also have conversations about taxes. After all, aren’t there accountants to handle that? Do we, as financial investment strategists, really need to dig into the world of 1040s, 1099s, and Schedule Ds?  

You already know the answer: yes. Taxes are yet another thread – and a big one – interwoven into your clients’ lives. To add value by offering investments and financial plans that help them reach their goals, you must understand what taxes affect them and how it changes their financial picture.  

You don’t need to be a tax expert in all things to offer value. Here are some very high-level places to start your tax conversations and what you need to know to speak intelligently and purposefully on the subject. 

• Understand and explain (if needed) how taxes tie into investments 

It’s not just about understanding the tax exposure of certain asset classes and the ratio of stocks to bonds (although that matters.) Many people don’t even understand their marginal or average tax rates and believe tax management is only for the rich. But looking at 2022 tax rates, marginal capital gain tax rates jump from 0% to 15% once a couple earns more than $83,350 in taxable income, hardly the jet-set. Income tax rates also jump at middle-class income levels. The many technical terms thrown around – unearned income, unrealized gains, capital gain tax – often make everyday investors glaze over. Understanding the basics helps advisors educate and make smarter decisions on behalf of their clients.

• Discuss the role of taxes when calculating what investments earn (don’t forget about liquidation!)

What matters to investors is how much money they can apply to their goals. If their goal is to pass wealth down, one set of rules may apply. But if they want to invest money so they can spend it while they are living, you must account for taxes not just on annual earnings but when the asset is sold. Many advisors don’t factor this into total return. Talking to clients about when they want the money can help you better predict how much they will have at a certain point in time. That helps them plan realistically and accordingly. 

• Take a look at forms to check for red (or yellow) flags

Ask to see your client’s tax forms and watch for signs that they have assets that aren’t being managed in a tax-smart way. So often, you will see a portfolio that relies heavily on dividends and interest income for investment return – even when these distributions are being reinvested into the investment accounts. This preference for current income may be creating unneeded tax headwinds. A practiced eye can spot opportunities to help clients and build their faith in you. You may even earn the chance to help them manage more of their investments. 

• Keep informed on tax code changes – with a special eye toward 2025

What happens in Washington, D.C., profoundly impacts how much an investor pays in taxes. The wise advisor will keep an eye on changes to tax law that affect investments. Of particular importance is what happens after 2025 when many of the tax reduction provisions of the Tax Cut & Jobs Act, which went into effect in 2018, expire. No one has a crystal ball, but it’s worth being prepared by brushing up on what investments may be most affected and talking to clients about appropriate contingency plans. 

• Suggest smarter ways to address tax-managed investing

This is where an advisor truly adds value – when you can spot ways to help improve a client’s situation. Sometimes it may be counterintuitive – deferring certain taxes yearly may make the tax bill look good in the short term, but focusing solely on deferring realized gains may lead the investor to own a suboptimal portfolio. It’s often the classic case of letting the “tax tail wag the dog.” Holding only municipal bonds may create tax-free income at the federal level, but it may be better to invest in both municipal and taxable bonds. Smart tax-loss harvesting can have a significant impact as well. Only by talking about goals, knowing your client’s risk tolerance, and knowing your stuff can you deliver real value.

Request Frontier Asset Management’s Tax Conversation Guide

My firm, Frontier Asset Management, has assembled this 80+ page guide with sections on tax terms, how to read a tax return, and examples demonstrating the impact of tax-smart investing. Consider it a primer or refresher to help you be the best advisor you can be. And don’t forget to check out Frontier Asset Management’s range of Tax-Managed Strategies as a way to offer our most tax-efficient investment solutions. 

You can’t be and aren’t expected to be all things to all people. But the ability to have a well-informed, productive conversation about taxes is one area where advisors can add real value and set themselves apart from the herd of advisors who only talk about stock/bond ratios and top-line returns. 

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