Our clients have worked diligently to build their wealth, and as their advisor, part of our role is to help them retain as much as possible to contribute to future goals. One crucial key to doing so is minimizing one’s tax burden.
The Importance of Tax-Efficient Planning
There are several reasons tax-efficient planning is key to effective wealth management:
- Avoid unnecessary tax liabilities: This might mean waiting to sell an investment until it’s been held for a full year, which will trigger a long-term capital gains tax rather than a short-term one—saving an investor 20% to 70% in taxes.
- Grow tax efficiently: We work with clients to ensure their qualified plans are well funded. These accounts grow tax-deferred with the expectation that in retirement, the client will be in a lower income bracket and withdraw the funds at a lower tax rate.
- Balance one’s tax liabilities: In addition to funding qualified accounts, we also help clients establish personal life insurance policies, where they contribute after-tax dollars that then grow tax-free and are distributed tax-free in retirement. This ensures a healthy balance of tax-free and taxable income to provide the funds needed in retirement without increasing their tax liability by distributing an excess amount from qualified accounts.
Strategic Partnerships: The first step in tax-efficient planning
There are numerous strategies to mitigate one’s tax burden, but the most important first step is coordination with their CPA.
At Vardhan, we regularly collaborate with clients’ CPAs to ensure we’re being as tax efficient as possible within the client’s overall tax structure. This requires regular reviews that provide all parties—the client, CPA, and us, the wealth management advisor—the information needed to implement proactive tax-saving strategies.
One thing we may discover during these reviews is if a client has carry forward losses. These allow us to take gains in an after-tax portfolio that can be offset, thus minimizing the tax liability. We may discover the tax liability has already been triggered if they have gains elsewhere, so now it’s about stopping excessive taxation in a particular year.
In many cases, we serve as the client’s central advisor in a multi-advisory relationship. Other professionals may manage elements of a client’s financial life, but we generally oversee their financial plan and coordinate with each party to determine the best integrated approach to support their sophisticated needs.
Minimizing Your Tax Burden Through Strategic Giving
Many of our clients are passionate about giving back to their alma mater, their child’s university, or other organizations close to their heart. With the robust markets of recent years, many clients have established substantial philanthropic goals. There are several tax-efficient ways to use their assets to fund these goals.
Donor-Advised Funds
Donor-Advised Funds (DAFs) offer numerous benefits for clients with philanthropic goals.
- Offset income tax: If you know you have an impending tax bill, you might consider donating cash to a DAF to offset that year’s tax liability.
- Offset a major capital gains tax: If you’re anticipating an event that will significantly increase your tax basis (such as the sale of a business or property), and you already plan to donate annually to charity, you might consider contributing a lump sum to a DAF that year to offset the tax burden of the sale. Those funds will then appreciate and be available for your future charitable goals.
- Minimize taxes on appreciated stock: DAFs allow investors to contribute appreciated stock, and in doing so, avoid paying taxes on the gains. This is particularly beneficial if you own a stock that has grown significantly in recent months. Rather than selling the stock and donating the (taxable) gains, you can gift the stock directly to an institution of your choice through a DAF—accomplishing your charitable goal and saving you money in taxes.
- Minimize taxes on private investments: If you own private shares of a company, we may conduct a valuation and suggest housing those shares in a donor-advised account. Then, when those shares eventually monetize, your tax bill will be negligible because the gain will have accrued in a tax-efficient account that you can then use for philanthropic purposes.
Contributing shares and appreciated stock to DAFs is a triple win. It allows you to meet your philanthropic goals, reduce your tax liability and preserve capital in other accounts for additional goals.
Depending on your situation, you may decide to contribute annually to a DAF or periodically to mitigate specific tax risks. We had a retired client who sold a property that elicited a significant tax bill for them. After discussing with their CPA, we recommended they transfer $1 million into a DAF that year, giving them a roughly $300,000 write-off against a multi-million-dollar tax liability. The couple was already planning to donate annually to 501(c)(3)s, so this amount aligned with their goals, and a lump sum contribution allowed them to take the write-off when they most needed it.
Family Foundations
Clients might also maintain foundations, which offer many of the same benefits as DAFs. We help strategically manage these accounts, determining the annual distribution rate and finding tax-efficient ways to gift money into the foundation.
Additional Tax-Saving Strategies
In addition to gifting strategies, or for clients who do not have philanthropic goals, we explore other innovative ways to minimize taxes, such as opportunity-zone investing, strategic gain-loss sales or institutional tax management strategies.
We recently developed a five-year Roth conversion strategy to help a client convert several hundred thousand dollars of IRA funds into a Roth, ensuring the amount fit within the client’s income threshold so as not to increase their tax bracket. These funds will serve as a legacy asset—growing tax-free, and later, distributed to the next generation tax-free.
Always Ask the Question
The most common tax-related planning mistake we see is not having proactive strategy sessions with the client and their CPA or other trusted advisors. At Vardhan, we don’t rely on others to initiate these conversations. We conduct regular, thorough reviews of our clients’ finances, coordinate with their CPAs, and determine how to best mitigate their tax burden.
For example, we recently brought on a client who had approximately $10 million in assets from various accounts, and in conducting the client’s personal financial audit, we discovered they had significant losses (around $3 million) in these accounts. We also noticed an impending $5 million gain on the sale of a property, so we suggested taking the losses in the accounts to offset the gain from the property sale. In doing so, the client was able to save $3million in capital gains taxes—a savings that might otherwise have been overlooked.
The bottom line is, we take responsibility as a fiduciary for your financial due diligence. We dig deep, ask pertinent questions, and make sure we—and your other professionals—are doing all we can to protect your earnings and preserve your legacy.