How These Financial Advisors Talk Tax-Planning with Clients

Derek Mazzarella: I think when you talk about tax buckets in general, to me it's like, we've got to make sure the clients understand the basics before we move on to the more complex stuff. I'll almost always go through tax buckets, and there are a few common misconceptions with it.

I'm very visual. I tend to use a whiteboard a lot, so I'll typically draw three squares. This may sound really silly, but I'll just draw AT for after tax. I won't write out after tax, because it takes a while. A lot of those little things can go a long way.

I'm also really big on analogies, because one of the most common misconceptions I see, especially when it comes to tax buckets — I'm sure everyone on this call that's a financial advisor has probably heard the question, what return does my Roth IRA get? What return does my traditional IRA get? And you're like, timeout, that's not how they work. The analogy I use is, think of these buckets as garages. Each bucket is a different garage, and the car is the investment. The car can go in any one of the garages. It's just how they're taxed on the way in and the way out — that's the difference.

I think as much as you can keep the concept simple, because once they understand the baseline of the three main money types and how they're taxed, a lot of the other conversations moving forward tend to be much easier to understand and digest for the client.

Warren Duthie: The hottest topic that I've seen in terms of tax planning is just the idea of Roth conversions. But before you get there, I work with a lot of — I'd call them HENRYs, as an acronym: high earner, not rich yet. If there's a lot of cash flow that is being generated in their life and they can save that cash flow, we can be strategic as to where to direct it. We're kind of directing traffic there: which garage should we start with?

And I love RightCapital because it gives you that picture of the tax brackets over a lifetime. So here I've got on the screen — you guys can see that, right? Yep, okay.

I've got Mr. and Mrs. Tax Bomb. Anytime you see this giant gap here, where the effective tax rate drops off a cliff — I had them making 400,000 a year, just two salaries, 200,000 apiece — you can see that effective tax rate, and then it just falls off a cliff. In my mind, the first thing that goes off is, that's ripe for some Roth conversions to fill in these low years and take advantage of it.

The idea there, for the tax bombs, is to think about on the backend these unused years. I strategically set this up with a ton of qualified money, IRA money, so that we could move a lot over, but I think that's probably not uncommon.

And then my favorite little slider in RightCapital is right there. Oh my goodness, that's the best. So we're just filling that in. That's not revolutionary for anybody on the call, but one thing I do like to do: normally this compared-to is set to pro rata. And when you come to this page, it spoils the punchline, because if you're doing a Zoom and you come over to this page, it's already got an $11 million win and they're looking at that immediately. So I like to match them up compared to, so it's exactly the same thing. Then when I move that slider over, it's showing how amazing we are so far, and I like to have that one at a time.

I think when we're beginning with the end in mind, that is one of — not the only, and we might get into this later in the video — but that's one thing that I really dig.

Warren Duthie: I have clients who are in their seventies, eighties, and nineties, and a lot of them don't really fully understand how, at death, your assets get an adjusted basis. Once they understand that their heirs aren't going to have to sell some of this appreciated stock that they've had forever and pay a ton of capital gains, they are really pumped.

So what I like to show is a couple things. This is the end of the road for the Tax Bomb family. I like to show them, look at the amount of tax-deferred money you have at the end of your life. If you want to look at it in percentages, that's a great way to do it. The other way I like to do it is the account balance, because if you're going to be doing Roth conversions, you can show them at the end of life what the amount in tax deferred is compared to a scenario here. The reason why is, okay, now my heirs are going to have to spend this money down.

I think with people with an aging book, they don't have a relationship with that next generation. That's a cool way to get a foot in the door with that next generation and get all those parties at the table. If you can talk about a plan and you can read the trust — what I love to do is get them to upload the trust on the vault here, securely. And then you have that. That also gives you the ability to demo and flex the planning that you've been doing for their parents.

Derek Mazzarella: So what I found is, if you go to this edit tab here, you can actually select when the Roth conversions start and stop. And I found that in different situations you could really save a decent amount of taxes by being more specific and saying, instead of doing every single year, I'm going to do from when this person's — you play with the buckets a little bit — 65 to when does that stop? 73-ish? You look at how it looks, and does that make the most sense? I mean, yeah, you have more here, but then I always go back and check the tax buckets.

So you go back to the Retirement tab. This is not something I do in front of a client, this is more for you as an advisor. You just want to make sure you have your playbook in your head, because I like to do this stuff live with clients — I don't know if Warren, you disagree — and when I do it live, I have this playlist in my head, because I want it to be a collaborative thing. I don't want this to be like our old school days where we just hand them a 90-page plan and say, do this, do this, do this, and give me my money. This is not how we do it. So I'll say, look what happens if we do this, and I'll show them live.

But you do want to double check your work. So we go to the Comparisons tab, you'll be able to say, this one's 88,000. Is that the right bucket? What if I play around with it a little bit more? And if this goes to just 70, is that a better outcome for the client?

Alexus Rogers: Yeah, that's a great point to be making too. Just to take a step back, when we're looking at the distribution module, what Derek's saying is that it's going to be calculating, where applicable, where they can fill up the tax brackets across their lifetime. So if we want it to be more specific, we can have it end and start at a specific timeframe. Especially as Derek's saying, sometimes it makes more sense to limit it, or maybe clients aren't comfortable going to age 80 doing conversions. So you can specify that, control it, and see how that impacts the plan. And like he's saying, it might still make sense if they do that different timeframe of the conversions rather than across all potential years.

Derek Mazzarella: Right. So this is in bold: when I ran the full conversion, they would've saved 83,000 in taxes, which is awesome. But then when I constricted it down from 65 to 70, they're up to $95,000 saving in taxes. So about $12,000 difference just by manually controlling things a little bit better. So anytime you're running this software, you want to think in the back of your head, is there a different way I should do this? Trust your eyes a little bit when you're seeing these charts and think, what if I converted more later? If you convert too late, is the benefit really going to be there? There may be an estate planning benefit, but there may not be the tax-savings benefit. And that's where you have to weigh with the client, what's actually more important for you? Do you want to save as much in taxes now? Or do you want to pass Roth IRAs compared to traditional IRAs on to your beneficiary? So those are the conversations you can have, and those are the things you can do in here when you're being a little bit more specific and targeted with this. So just don't run the generic numbers, I guess is my point. Go a little more detail and see if you can target a little bit, just to play around and see if it makes sense. So that's probably what I would say when it comes to the tax tab here. Incredibly powerful, but you really want to give it a backend look.

Alexus Rogers: Yeah, absolutely. Derek, just one thing. If you can go back to the tax tab for me. Let's go back into distributions. Under distributions, let's go to the details tab.

So especially when we're having the conversation about when are we doing Roth conversions and how much are we converting, this details tab is where you can see specifically how much we'd be converting each year to fill up that specified tax bracket. That's one of the questions that was popping up, so I wanted to answer it while we're here. But especially when you're trying to get that additional resource of what's happening, you can also see that gauge here. And if you're having a conversation with a client, like I said, maybe they're not comfortable doing conversions at age 80, maybe that's not right for them. You can also see here, are we actually doing conversions at age 80? Is that applicable for them?

Derek Mazzarella: And a lot of our planning is really interrelated. So anything we're doing is going to impact something else here. The nice thing about the distributions tab is that, if we go hog wild, I can say, look, I'm going to pump you up here and we're going to save a ton of taxes. But then when you really do the math on it, now they're paying more for Medicare and their premiums go up. And even if you go up just two Medicare brackets, your premium's doubling.

So one of the nice restrictions you can set on here is looking at, I want to keep it to my Medicare bracket. For some people that could be really life-changing money, and for some people it's not. For some people the bar is high or not, but I think you just really want to make sure you're having that conversation with them about it, because it lets them know that you're really on top of a lot of the small details.

Derek Mazzarella: I think you always have to phrase everything, because if you really look at it, almost anything we advise a client on is a tax decision. Whether it's, you should save more in your 401K, you should buy a permanent life insurance policy — literally almost everything we touch is going to be a tax conversation.

But I think it's important to outline, first of all, we're not CPAs, we're not accountants. You should really double check everything we're saying with your accountant. When you're thinking, as an advisor, about the difference between planning versus actual advice: planning is more of a what if we did this scenario? What if this versus this? You show the different potential outcomes. Versus, you should absolutely do this specific thing and take this money out of this account every time. To me, that's the real difference.

On this side of the coin, we're saying, what if we did this versus this? You don't have to run that by the CPA. But when it comes down to, we recommend you take this amount out, that's where you really want to double check with the CPA and say, this is what we think we should do, just make sure it's in line. That, to me, is how you should relay it.

Warren Duthie: Yeah, it's basically the same thing. Preface everything: I'm not a CPA. This is just like if I was talking about legal advice, I would say a disclaimer — I'm not a lawyer and I don't give legal advice, by the way. But the dream is if the three of us — you, your CPA, and myself — can get on a call together and figure this out that way. It's going to be really productive, and it's not going to be a bunch of emails crossing in the night. That would be the dream.

And then I would also tell them, upload your 1040 from last year on the vault, because I'd like to compare it with my software, just to see if I can get more familiar with your situation. That's only going to serve you well. And that also grows roots in the relationship. If they know Warren has my 1040 and he's looking at it... We've had some awesome conversations with clients and their CPAs, or one-on-one with the CPA, and the CPA gives us a glowing review.

But all that to say, we're never going out on the line saying, I'm going to prepare your taxes, I'm going to give you tax advice. I say, in order for me to be a great advisor to you, I have to know how taxes work. But that doesn't mean I'm going to actually file your return.

Derek Mazzarella: There are a few things I do. At the beginning of the year, typically mid- to late-January, I start sending out this email blast to all my clients: when to expect your 1099s. And I've got to tell you, as an advisor, I don't know how many people get calls — when's my 1099 coming? — and emails — when's my 1099 coming? Once I started sending that letter out, my calls and emails asking that question dropped by about 80%. So I'm very proactive in saying, you've got this account, it's expected in this date range. And that's really been helpful.

I also have a newsletter, and typically in my January newsletter, I lay out some tax checklists that you need to go through. Make sure you go through your children's expenses for daycare, and go through a couple common missed things that people have.

And the last thing is, you just look at your book and say, who hasn't made contributions yet for last year? Should I reach out to them and see if they still want to make anything? Are there any last-minute tax moves we want to do? So those are probably the three main things I do to help clients get prepared for taxes.

Warren Duthie: Yeah, we have a calendar year deadline where we're having Roth conversion conversations in the beginning of the year, with reviews, and thinking, I want to have a better picture of what your total income's going to be before we actually pull the trigger on this — unless the spaghetti hits the fan with the stock market. In that case, we have this whole list that we're going to be proactively reaching out to everybody, recommending that we accelerate those conversations. So we have a calendar year deadline.

Same thing with 401K contributions for solo 401Ks. If there's money that needs to get in on a calendar year basis, we want to make sure we don't miss any of that. So those calls are all being prompted to happen in October.

Derek, in our prep, I totally stole that idea as well about the proactive email, because we're just getting tons and tons of emails about when is our 1099. And a lot of times we can just send them out anyway, email them directly. But I think to the extent that you can preemptively address something, that's better.