Lon Jefferies, a Certified Financial Planner™ (CFP), is a fee-only financial advisor and trusted fiduciary at Net Worth Advisory Group in Salt Lake City, Utah. He is dedicated to providing comprehensive financial planning and investment management on a fee-only basis.
Is Your Financial Advisor Doing His/Her Job? Year-End Action Items
Is your financial advisor doing his/her job? If not it could cost you thousands of dollars in taxes and penalties. Year-end is a good time to test your advisor’s dedication to your financial success. Prior to the end of the year there are three things that should be addressed: capital gains, required distributions, and Roth IRA conversions. If your advisor hasn’t reached out to you to address these issues it may be time to hire another advisor. Let’s talk about each action item.
Avoiding Capital Gains Taxes
First, you need to take a look at the investments in your non-retirement accounts to see if you have any capital gains that will add to your 2011 tax-burden. For example, let’s assume you bought a stock for $10,000 in 2009 and sold it in 2011 for $20,000; a gain of $10,000. You will have to pay a capital gains tax of $1,500 (15%) on your $10,000 profit. Even worse, if you owned the investment for less than one year the income will be counted as ordinary income, which can be taxed as high as 35% (creating a tax bill of $3,500!). However, you can avoid the tax by finding another stock/bond/mutual fund in your portfolio trading at a $10,000 loss. By selling the stock and incurring the loss it will cancel out the gain for tax purposes. In this example the strategy will save you $1,500 in taxes (or $3,500 if the profit is counted as short-term capital gains!). If you like the stock or fund you sold you can simply buy it back 31 days later. By reviewing your taxable account(s) your advisor can check your capital gains and look for ways to offset those gains. If this isn’t happening your advisor is not doing his/her job.
Avoid a 50% Penalty
Second, if you are over 70 ½ you are required to withdraw some money from your IRA. If you don’t take the required distribution you’ll have to pay a 50% penalty. For example, if you are a 72 year old with a $500,000 IRA you are required to withdraw $19,531 and pay income taxes on the distribution. If the distribution is not taken the penalty is 50% of the amount you were expected to withdraw. In the case of our example the penalty would equal $9,465! If you are over 70 ½ make sure you take your distribution. Again, if your advisor isn’t doing his/her job and overlooks required distributions it could cost you.
Convert to a Roth IRA
Finally, if you are in a low tax bracket in 2011, which may occur if you lost your job or recently retired, you should consider converting some of your traditional IRA money to a Roth IRA. Be aware that there are pros and a cons when you convert. The “pros” of converting is that once the money is in a Roth it will grow tax-free throughout retirement, and annual minimum distributions are not required. The “con” is that you will have to pay income taxes on the money you convert. However, if you are in a low tax bracket your tax bill will be small.
It may makes sense to convert to a Roth and pay the taxes now if you are in a lower tax bracket so you can avoid paying the taxes later when you may be in a higher tax bracket. This strategy could save you a lot of money over time. For those in a lower income tax bracket, you could very well benefit from a Roth conversion.
Now that we are closing in on the end of the year you can see how much income you’ve earned and determine at what rate you’ll be taxed. Your advisor should be aware of your annual income to help you determine whether a Roth conversion might be a good option. If your advisor isn’t aware of your annual income amount, you may want to look for an advisor who is a little more on top of things.
The Bottom Line
At Net Worth Advisory Group, we review all of our client’s accounts to see if there are capital gains issues, monitor distributions for our clients who are over age 70 ½, and make sure we are familiar with our clients income so we can help them decide if a Roth conversion makes sense. This is routine for us in November each year.
If your advisor is not talking to you about these cost saving strategies I’d recommend you contact them, have a frank discussion about why he/she hasn’t contacted you to discuss these three strategies, and consider hiring an advisor who won’t let things fall through the cracks.