Although people would like their accountant to offer tax tips, many CPAs do not. They simply prepare the tax return and let their clients leave to accumulate another tax bill for the next year. I know, I’m a CPA.
I began my career as an accountant and notice that my counterparts tend to draw comfort from accounting rules and historical events. They like known variables and are uncomfortable dealing with uncertainty. Chances are, taxpayers do not get very forward-thinking advice from their accountants.
If an accountant gives advice, it often considers only tax benefits for now, without giving thought to tax liabilities his client’s beneficiaries may incur as a result of the investments he has recommended or blessed. Accountants also tend to give basic advice, e.g.: buy municipal bonds, defer income until next year, bunch up your deductions etc. These are shallow issues that don’t save people much money in the long run. For example, I had an accountant tell me to take the largest loan possible on a new home purchase and invest what I did not need into municipal bonds. The after-tax benefit to me was a whopping $2,000, which was not going to change my lifestyle or even buy a nice vacation for a week.
Because accountants often lack the orientation to look far into the future, some accountants don’t think to warn clients about potential tax liabilities that could severely impact their beneficiaries until it’s too late. For instance, an affluent investor should know the danger of owning an annuity or IRA in their estate at the time of death — information that the accountant usually won’t offer when he recommends an annuity or funding an IRA. Annuities or IRAs held at death could be double taxed if the investor is subject to estate taxes. The total tax bite could claim over 70% of the value of these assets!
Financial Advisors MUST Provide Investment Related Tax Advice
Every financial services firm has a disclaimer on their literature, “we do not provide tax advice.” But this will create more liability than it prevents. For example, how happy might a client be if their advisor purchases for them shares in a fund with huge accumulated tax liabilities? Or on November 30, just before a huge capital gains distribution? I’m not recommending you become a tax advisor, but you must provide investment related tax advice because you cannot do an ethical or complete job without doing so. And most importantly, this is where you can add value which more and more advisors have difficulty providing and communicating in a commoditized world.
Less than 10% of the annuity owners that I meet with make any withdrawals from their annuities. Should the owner die, the policies can get hit with some very large tax liabilities. If your client wants to avoid saddling his beneficiaries with estate taxes, he may want to annuitize the annuity. The client selects a payout option that may include a lifetime income from the annuity company. The shorter the time span, the higher the monthly income is. Further, if the income is not required, a client may annuitize his annuity into a life policy payable to his beneficiaries. Properly structured, estate-tax exposure is eliminated and the beneficiaries often get 5 times more than they would have by inheriting the after-tax annuity.
Another area where accountants fail is that they do not give ongoing advice. Most investments are susceptible to market fluctuations or changes in interest rates. Say an individual purchased a fixed annuity with a rate of 9%. A few years later that same annuity might pay at a rate of only 5%. Many accountants won’t think to consistently remind their clients about rate fluctuations because the initial objective of income tax reduction has been achieved. Individuals may be unaware that they can switch to an annuity that will pay more and offer a locked-in rate, rather than one that changes. Under Section 1035 of the Internal Revenue Code someone may switch from one annuity to another without payment of taxes. Of course, these individuals should know that they might be subject to surrender charges for leaving their current annuity. But how many accountants delve into their clients’ investments and provide such advice?
The same is true for the IRA investment. It is important to realize that the smart thing to do for income taxes, and what an accountant advises, could be the dumb thing to do for estate taxes. Most accountants advise to defer income taxes for as long as one possibly can. They therefore advise the IRA owner to defer distributions as long as possible, which leads many accountants to suggest the stretch-IRA concept or a Roth conversion. But in their efforts to pass on the largest IRA balance to heirs using the two options, IRA owners could give up to 55% of it to estate taxes under current rates. Individuals whose IRA is most of their estate have it even worse. Their heirs will be forced to liquidate part of the IRA and pay income taxes for the purpose of paying estate taxes! But is the average accountant thinking about the big picture like you do?
Now that we’ve examined two cases where an accountant’s lack of forethought might cause difficulties, let’s take a look into three other items of advice that an accountant typically won’t provide to his clients but you should.
First off, the pension asset transfer strategy.
Through this strategy, a life insurance policy is purchased
in the retirement plan and later distributed to the participant
at 56 cents on the dollar, for tax purposes (distributions
of life policies are taxed at their cash surrender value).
In other words, 44 cents comes out of the plan tax-free.
Even though IRAs cannot own life policies, this strategy
can even work for someone who has an IRA rollover. The
prospect needs to generate small amounts of earned income,
establish a qualified plan, and the IRA can be rolled back
into a qualified plan. The qualified plan may own life
Not only does the participant save income tax, but he also gains two other benefits. The retirement assets, now in the policy, can grow tax deferred indefinitely (or tax-free if left to be paid out as a leveraged death benefit). In effect, the participant has allowed his retirement assets to continue growing, but has terminated any future tax liability (if left as a death benefit). The owner can also choose to gift the policy to beneficiaries and remove it completely from his estate. The result: he beats the double taxation (income and estate tax) on the future value of his retirement assets for a much smaller tax payment today.
Another idea is Emerging Money Corporation’s Stock to Cash program (www.emergingmoney.com). This program allows an individual to borrow up to 90% of his stock portfolio value without selling shares. The strategy uses only non-callable and non-recourse stock loans; of which most accountants are unaware. Unlike traditional margin loans, the lender can never call the loans in this program. The client has the right to default if his shares do not perform (with no entry on his credit record) and he also has the right to recover shares by paying back the loan. By borrowing rather than selling, the individual avoids immediate and possibly indefinite deferral of capital gains taxes. Additionally, upon death, there may be an estate tax discount for lack of marketability since the owner’s heirs will inherit the collateral shares subject to the loan.
The run-of-the-mill accountant will also not address the potentially costly subject of turnover rate in a mutual fund, and the fact that this leads to higher taxes if the fund is selling stocks with lots of short-term gains. The accountant ignores the correlation between a fund’s turnover rate and its after-tax return: high turnover increases the investor’s tax impact.
Being a financial advisor differentiates you because you are conditioned to look toward the future and your job requires that you examine all possibilities. Your view is holistic. Further, you are there to provide ongoing guidance. To really separate yourself, and give your client the best possible service, realize the multitude of tax issues surrounding your investment advice and where you can be of truly added value. Communicate often to clients and prospects this value-added reason for doing business with you.
Larry Klein is a CPA, Certified Retirement Financial Advisor™, Registered Investment Advisor and he holds an MBA from Harvard Business School. Over 5000 financial professionals use his marketing system to obtain more and better clients, increase money under management, increase commissions and earn more while working less. His programs are in use by brokers at most major securities firm, many NASD firms, and by hundreds of independent insurance agents and captive agents with large, well-known insurance companies. Details on his winning marketing systems and his complete book on Marketing Financial Services to Seniors are available .