There are many different variables to consider when selecting an advisor. One important component that determines a financial advisor’s success is how well they can manage investments. Financial advisors need to understand how to minimize taxes related to the investment recommendations they are providing to their clients to manage investments effectively. To help clients minimize taxes, an advisor needs to have a complete picture of their client’s financial situation.
Many data points need to be collected to obtain a complete picture of a client’s financial situation. If a financial advisor or a CPA is not collecting these data points, it is impossible to identify several types of tax minimization opportunities. Unfortunately, in my experience, most investors are under the impression that if they have a financial advisor and a CPA, these data points are actively being updated and monitored to employ effective tax minimization strategies on an annual basis. I find this is rarely the case.
I believe tax minimization strategies are missed because of something I call “The Gap.” The Gap occurs because people typically pay their CPAs to provide tax preparation or accounting services. They frequently do not pay their CPAs to provide tax planning services. Tax planning is generally a service that a CPA will provide upon request for an additional fee.
Similarly, many people do not receive comprehensive tax planning services from financial advisors who primarily generate their compensation based on investment management services. In essence, this creates a situation where nobody is collecting the necessary data that is required to provide a variety of different tax minimization strategies. One way to help identify if you are missing out on tax minimization strategies because of The Gap is by determining if your advisor is actively maintaining essential data points.
The type of data that is required to provide comprehensive tax minimization strategies includes but is not limited to:
- Current income streams.
- Expected future income streams.
- Net worth statement.
- Current and future charitable contributions.
- Anticipated large expenditures.
- All available retirement plan options along with contribution limits.
- Annual contributions to retirement accounts.
- Health insurance needs following retirement but before Medicare.
- Anticipated inheritances.
- Anticipated business sale(s).
- Anticipated retirement date.
- Future estate aspirations.
- Other financial goals.
If you are working with a financial advisor or CPA who is not actively maintaining the data points listed above, there is a good chance you are experiencing The Gap. This occurs because there are many tax minimization strategies that can only be identified if the data points listed above are known and are current. Unfortunately, many advisors do not actively maintain current information on the above data points, and tax minimization opportunities are lost.
Over the years, I have written about a variety of tax minimization strategies that commonly get overlooked due to The Gap, including tax sanctuaries and charitable stacking. One strategy individuals planning to retire before age 65 will want to consider is how to plan for affordable health care before Medicare.
Without knowing an individual’s net worth, expected future income streams, and anticipated large expenditures, an advisor will not be able to accurately plan for tax credit savings through a health insurance exchange that many early retirees will depend on for their health care needs. This is just one example of why having your advisor collect and review this information regularly is so important.
It is crucial to verify that your financial advisor is actively maintaining the data points listed above to ensure you are not missing out on tax minimization opportunities. I would define active maintenance as updating the data points at least annually. Fortunately, a growing number of financial advisors and CPAs are taking a more proactive approach toward holistic tax planning.