Down Market? 3 Ways Advisors Can Use Tax Planning to Help Clients
By Ben Birken, CFP®
When the markets are down, the average advisor could set a timer to when the first anxious client will call for help. They may just be looking for you to talk them down from the edge, or they may be ready to pull the plug on this whole “investing” thing.
As much as advisors talk about focusing on the long term and keeping a cool head, these conversations will never fully be a thing of the past.
When clients are worried, few things calm them down more quickly than knowing you are taking some sort of action – but what should you do (that doesn’t involve selling everything)?
In this post, we’re outlining three tax planning strategies you can leverage in a down market to help calm your clients – and save them money in the process.
3 Tax Strategies for a Down Market
While the market roils, the power of proactive tax planning activities can help clients find the silver lining in the storm clouds and weather down markets.
1. Tax-loss Harvesting
Tax-loss harvesting – selling securities at a loss to offset capital gains taxes incurred from selling other securities at a profit – is a great strategy for down markets. Any losses in excess of gains can be used to reduce other income by up to $3,000, with any remaining losses carried forward to the next year.
While clients may lose money on a specific investment, lowering a client’s overall income can potentially save them big bucks on taxes come next spring. If your client is experiencing loss in one or more of their investments, tax-loss harvesting is a great tool that offers reassurance that you have an action plan in place.
2. Roth Conversions
If a down market is pushing your client into a lower income tax bracket, it may be time to talk about Roth conversions.
A Roth conversion occurs when you roll money from a traditional retirement account into a Roth IRA. Roth IRAs are taxed based on your client’s current income at the time of deposit, whereas traditional IRAs incur tax at the time of withdrawal.
Performing a Roth conversion after a market downturn may not change the amount of money you planned on converting in a given year. But it could potentially set up the Roth IRA for more growth when markets eventually start going up again, compared to performing a conversion at the end of a bull run.
Lastly, your client may want to consider “frontloading” their retirement contributions, be it to 401(k) accounts, Traditional/Roth IRAs, SEP IRAs, solo 401(k) accounts, etc.
Frontloading involves investing the maximum amount of funds earlier in the year rather than spacing the payments out throughout the entire calendar.
If you believe the down market may even out soon, your client can benefit from investing their funds prior to that rise – resulting in bigger gains overall. It’s similar to timing the market – but with a little more strategy involved.
But there’s a small risk. Frontloading 401(k) accounts may result in missing out on some employer match dollars. And an unforeseen change in income may make someone ineligible for a Roth contribution or Traditional IRA deduction, or might change the amount that could be contributed to a SEP IRA/Solo 401k. An advisor needs to be confident in a number of variables to work with this strategy.
If a down market has your clients on edge, these three tax strategies can help them keep their cool (and maybe some more money in their pockets).
A Fourth “Strategy”: Show the Actual Cost of Acting
Many advisors share with their clients how much they stand to lose if they are out of the market for just a handful of days, citing historical long-term return numbers with the best days extracted.
But those returns are hypothetical and long-term in nature. If your client is insistent on exiting the market and they have taxable accounts with gains, you can show them how much that will cost them right now by adding the amount of realized gains to any tax projections. Maybe seeing the cost of acting could be the thing that encourages them to hold off on doing anything that would jeopardize their long-term plan.
Deliver in a Down Market with Holistiplan
Holistiplan’s tax-planning software makes it easy to show your clients clear deliverables in just moments. Click here to schedule your free trial of Holistiplan today.