2020 Year-End Tax Planning for Retirees

2020 Year-End Tax Planning
Links Mentioned on this Episode

Complimentary Consultation Podcast: What Retirees Need to Know About Roth Conversions

Dean Barber: Thanks so much for joining us here on America’s Wealth Management Show. I’m your host Dean Barber, along with Bud Kasper and special guests with us, also is JoAnn Huber.

Bud Kasper: Yay!

Dean Barber: Yay!

Bud Kasper: Finally, back!

Dean Barber: Well, here we are, December 2020.

Bud Kasper: I know. Now we’re counting down Christmas.

Dean Barber: You know-

Bud Kasper: First, we counted down the election-

Dean Barber: No, no, no, we’re not counting down to Christmas. We’re just saying, “Get us the hell out of 2020, please.” Everybody’s thinking, “Just let me close my eyes, open them up, and 2021 will be here.”

Bud Kasper: Yeah. No doubt.

Dean Barber: Just get me out of this mess. 

Bud Kasper: You what I think about with that is once the vaccine is out and well distributed, you know how busy it’s going to be? I mean, stores will be packed, airlines will be packed as well. 

Dean Barber: It can’t come soon enough, in my opinion.

Bud Kasper: Yeah.

Dean Barber: There are a lot of things out there! The reason I bring that up is not to talk about COVID-19, not to talk about the economy or anything like that, but people are so worn out right now, and they are only thinking about, “Just get me out of this year. Let’s move me into 2021. Things will be different. It’ll be a new year.” 

Taxes in December?

But before we get there, we want to talk about something critical this time of year. It’s not a shopping list, and it’s not what are we going to make for Christmas dinner, or what are the travel plans? It’s taxes. I know it’s crazy to think about taxes in December, but JoAnn, December is perhaps your third busiest month behind March and April. Right?

JoAnn Huber: Absolutely. And I don’t think most people realize how busy it is at the end of the year for taxes. And that’s the time that people need to be looking at things because this is your last chance.

Bud Kasper: And it isn’t necessarily on the returns. It’s on the preparation for not getting taxed next year.

Last Chance to Impact Your 2020 Taxes

JoAnn Huber: Well, this is where the planning happens. And this is your last chance if you’re going to do something to impact your taxes, there are very few things you can do after December 31st. So you should ask yourself, “What should I be doing between now and the end of the year?”

Bud Kasper: Yet we know that people aren’t thinking about that, are they, Dean? 

Dean Barber: No, it’s the last thing on our minds right now. Good tax planning, proactive tax planning generally starts in January. So it’s December now we’re finishing up what we planned in January and February, and also in December, we’re beginning to etch out our plan for 2021. 

Then in January of 2021, that’s when we finalize, okay, this is how we’re going to get our money this year. This is where we’re going to make our deposits and how we’re going to give away to charities. This is our plan.

Chances of New Tax Laws Are Very Real

As you go through the year, as witnessed by 2020, there can be multiple tax code changes, and we have a new administration coming in. So the possibility of new tax laws in 2021 is very real. 

JoAnn Huber: They are.

Dean Barber: Right?

JoAnn Huber: And I think we’ll have a better idea once we know what happens in Georgia with the Senate elections.

Dean Barber: That’s going to linger into 2021. If you haven’t already done some planning for 2020, it’s going to be tough to get a lot of things done this year. But the great thing about tax planning is it’s an ongoing process.

We can help you get organized and plan for the future. Get a complimentary consultation by clicking here.

We’ve said this many times, “As long as you live in the United States and as long as you have money or make money, taxes are going to be a fact of life.” 

Even if you didn’t get something done in 2020, and it wasn’t the right thing, now’s the time to start looking at 2021 and beyond. And we can start focusing on the future and put 2020 in the rearview mirror.

Bud Kasper: I think it’s important for people to understand that, as advisors and planners, we have gone through a metamorphosis in the sense that we are focusing on taxes more than ever before. We realize how critical it is to the financial outcome of our clients.

Every Financial Decision Will Impact Your Taxes

Dean Barber: Well, JoAnn, there’s almost not one thing that people do in their financial lives that doesn’t at some point get onto the tax return.

JoAnn Huber: Right. And that’s what I tell people repeatedly because every financial decision is somehow going to impact your taxes. And maybe it’s not that that actual decision will be on the tax return, but it will trigger something else that will cause something to be taxable or deductible.

Bud Kasper: How many people out there don’t have these relationships with accountants? All they have is a relationship with a financial advisor who doesn’t necessarily have the expertise, nor do they have the capability of actually making tax assessments. 

Dean Barber: That’s an issue, JoAnn.

“I have an easy question for you.”

JoAnn Huber: It is. And it’s incredible to me how much people don’t understand. Somebody called yesterday and was like, “I have an easy question for you.” I’m like, “Okay, what is that?” “Well, do I take a distribution? Do I take money out of my traditional IRA or my Roth IRA?” I’m like-

Dean Barber: That’s not an easy question.

JoAnn Huber: Nope, but in his mind, it’s just straightforward. I think many people have that misconception that it’s just a really simple thing. However, without having a complete financial plan and knowing what you’re trying to do now and in the future, you really can’t make that decision. Well, I guess you can make the decision, but it might not be the right decision.

Dean Barber: Right. But what winds up happening there, JoAnn, is people make a decision, and they look only at the current year’s consequences. And that’s where the mistakes come in is they’re not thinking about the ripple effect of that decision in years to come. 

JoAnn Huber: That’s where it goes back to what you were just saying that every financial decision does impact your taxes at some point. And if you make a wrong decision today, are you going to overpay your taxes in the future?

Dean Barber: No, we know you are. We see it all the time.

JoAnn Huber: All the time.

Dean Barber: I encourage you to get your complimentary consultation by clicking here. 

Dean Barber: We know that it’s the Christmas season, and everybody wants to start thinking about all the great things, and we want to get 2020 behind us and move into 2021, but there are some things, JoAnn, that people need to be thinking about right now as it pertains to their taxes. 

Required Minimum Distributions

Let’s start with our older generation. Of course, now we have some of the baby boomers that we can say are in the older generation because they are over age 70 1/2. Suppose they were over age 70 1/2 by January 1st or over 72 this year. And why do I say that? Because we had a screwed up tax code that changed the required minimum distribution date from 70 1/2 to 72, but if you were already 70 1/2 by January 1st, you don’t get to use that 72 age.

JoAnn Huber: Right. But then it ended up being even more confusing because of the CARES Act that came in and said you don’t have to take a required minimum distribution this year.

Dean Barber: Right, and of course the CARES Act is, we’ll call it the bailout package or the stimulus package that Congress put in place due to the COVID-19.

JoAnn Huber: Right.

Dean Barber: Right. So the required minimum distribution is what we’re talking about, and it’s also affectionately called the RMD. I like to think of it as Uncle Sam tapping you on the shoulder, saying, “Hey, I’m tired of waiting on you to die to get my share of that. Start taking some out so you can send me some of it.” That’s exactly what’s happening there.

It’s the Taxman!

Bud Kasper: You talk plain, Dean. You talk plain.

Dean Barber: It’s the taxman. Come on, Bud. I’m tired of waiting for you to go. Give me part of my money.

JoAnn Huber: It’s time.

You Don’t Have to Take Your RMD in 2020, But Should You?

Dean Barber: But the reality is that IRA is not your money. Not all of it. And only part of it is. And so this year, you don’t have to take that required minimum distribution if you’re of an age where the requirement of distribution has been something that you’ve had to do. You don’t have to do it. And so a lot of people are just stepping back and going, “Oh goody, I don’t have to take that this year. Well, that means I don’t have to send as much money off to Uncle Sam,” but the real question becomes should you anyway? And JoAnn, don’t say it depends, because that’s always your answer. 

JoAnn Huber: Well, I’ve seen more people this year, when we’re making projections, that are going to have negative taxable income. Because they don’t have the required minimum distribution, and they don’t have taxability of their Social Security because they don’t have the distributions, and they’ve been living off of their taxable account. And so if they have negative taxable income, they’re leaving money on the table and saying, “Here, IRS. Just keep that. I’m glad that you’re going to do that.” So that’s where people need to look and say at least get to break even. 

Dean Barber: So at least take enough out of that IRA so that your taxable income equals your standard deduction.

JoAnn Huber: Right. Then the question has to be, “Well, if I’ve taken that much, should I take a little bit more?”

Bud Kasper: Yeah. And the answer is probably, as long as you stay in the 12% bracket, right? 

JoAnn Huber: Right.

All About the Brackets

Dean Barber: We’ve had so many instances that you and I have looked at together, and I know you’ve been working with Bud and all of our advisors here at Modern Wealth Management looking at our clients, but we look at so many scenarios where we can say, “You know what? We can get money out of an IRA this year at a 12% bracket, and we know that next year it’s going to come out in a 22% bracket. Well, it’s almost like a 50% discount on my taxes. Okay, I’ll take it.”

JoAnn Huber: Right. So if you went into the store and you saw something on sale that you wanted for that, wouldn’t you be all over it? And I mean, it’s the same way with taxes.

Bud Kasper: Yeah. You don’t even have to wait until Black Monday, or Friday, or whatever it is. It’s Black December. It’s just constant. 

Roth Conversions

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“The Roth IRA, I think, is the best piece of legislation ever written because once you put your money into it, it starts growing tax-free. It accumulates tax-free, and then it comes out and distributes tax-free either to you or to your beneficiaries. “

– Dean Barber

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Dean Barber: Yeah, no doubt. But that’s been the deal with taxes this year, especially because of this RMD, is that people have had an opportunity throughout the entire year to think about should I take my RMD? And what we’ve been doing with a lot is saying, “You know what? If we don’t have to take the RMD, let’s take what we can, get up to the top of that bracket that you’re in today, and let’s convert that over to a Roth IRA.” 

Of course, the Roth IRA, I think, is the best piece of legislation ever written because once you put your money into it, it starts growing tax-free. It accumulates tax-free, and then it comes out and distributes tax-free either to you or to your beneficiaries. So you pay tax on it once to get it in, and then forevermore, it’s tax-free. If I could get everything I had into a Roth IRA, I’d do it tomorrow.

The Seed or the Harvest

Bud Kasper: Yeah, but we know that the government is quick to put their hand out, and they created it so they could get some fast money that way. But if we use it, if we’re smart about this, we can postpone that. And I always use the saying that, Dean, you and I were familiar with many years ago, and that is either pay tax on the seed or tax on the harvest. Pretty simple.

JoAnn Huber: And what we’re trying to do is say, “when will my tax be the least amount? Is it going to be when it’s the seed or the crop?” 

Bud Kasper: Correct.

Changing the RMD Age?

Dean Barber: And now, there also are some discussions going on in Congress right now to muddy the waters just a little bit more about potentially changing that required minimum distribution age to 75 as opposed to 72. Has anything come out from the IRS about that?

JoAnn Huber: I haven’t heard much about that. One thing that did happen earlier this week is they did release the new requirement or the life expectancy tables, I think is what it’s called, but those are not effective until 2022. But that will make a difference and reduce the amount people have to take starting in 2022. And people need to be careful in 2021 that they’re using the right table.

Dean Barber: So is the divisor larger in that new table so that the draw percentage is smaller? Is that what’s happening?

JoAnn Huber: Yes.

Dean Barber: Interesting.

JoAnn Huber: Because people are living a little bit longer.

Bud Kasper: But that makes a lot of sense, though. They’re late to the party in terms of having that happen. We saw it when we had full retirement age increase; now we have the 72 and maybe 75. I just don’t think 75 is realistic in terms of the amount of capital that the government needs to postpone.

JoAnn Huber: That’s where I’m at with you, Bud, as I don’t think they’ll postpone it because they don’t want to be patient anymore and wait for their share of your retirement account. 

Bud Kasper: Yeah, what do we call it? The money grab, Dean?

The SECURE Act and Changing the RMD Age

Dean Barber: Wait a minute, though, the SECURE Act fixed all that. That’s why they can do this. Think about it from a perspective of if somebody dies now with more money in their IRA, what happens? All of it comes out. It’s not a little required minimum out; it’s all got to come out now when it passes to the beneficiaries within ten years. 

So I don’t think, “Oh, they’re being nice.” No, they’re not being nice. And the whole SECURE Act was the biggest bunch of B.S. I mean, it’s horrible. We did an entire video on the SECURE Act, and we’ve had to adjust a lot of our estate planning due to the SECURE Act. Look, here’s the thing, taxes have gotten more complicated in the last 24 months than they were prior. And there was no simplification of the tax code. It’s more complicated.

The more complicated it becomes, the more opportunity you have to take advantage of the tax code’s new provisions. You need to understand what those are. You need to learn about that. Watch our video on Year-End Tax Planning for 2020, and request a complimentary consultation. Look, we need to sit down and talk about what you’ve got going on because if we can understand your financial picture from a CPA’s point of view with a financial plan in place, the amount of taxes you can save over your lifetime will blow your mind. You can watch the video and set an appointment right there on the website.

Back to the SECURE Act 

JoAnn Huber: I want to go back to what you were talking about, the SECURE Act, and you talked about how it made it, so we had a lot of estate planning changes that happened. It also has a lot of tax planning changes.

Dean Barber: For sure.

Estate Tax Exemption

JoAnn Huber: And so we always talk about, when we’re doing tax planning, we want to do 10, 15 years and say, “What does it need to be?” But with the SECURE Act, we’re now doing a lot of multi-generational planning. And we have to look at that because, with the estate tax exemption amount where it is right now, which is about $11.6 million, I believe, then most people aren’t going to have an estate tax issue; they’re going to have an income tax issue.

Bud Kasper: Yeah, but you want to bet where that $11.6 million stays.

JoAnn Huber: Right, but let’s face it, there’s still going to be the tax. The income taxes are the crucial part because if we can save money on the taxes, we can work around estate taxes. There’s always the estate planning we deal with, but what do we do now to minimize the taxes?

Planning Has to Be Early

Bud Kasper: But that planning has to be early.

Dean Barber: Oh, for sure. I mean, it’s not one of those things where, “Hey, Uncle Joe, he’s in the hospital, he’s got three weeks to live. Let’s get an attorney in there and draw up a will real quick.” That’s not how this works. 

JoAnn Huber: No, that’s not planning. That’s just making sure things can transition easier.

Dean Barber: Yeah, and when I talked about how it’s changed the estate planning, JoAnn, I wasn’t talking about estate taxes, I was talking about the plan on how you’re going to distribute money to the next generation.

JoAnn Huber: Which ties right into the taxes.

Dean Barber: And it’s all about the taxes. It’s all about keeping Uncle Sam’s greedy little fingers out of your pot of gold. Ensure that it goes to the people you love and the people you care about, not to Uncle Sam. Look, there are ways to do it. 

Bud Meets Johnny Cash

(Music Playing: After Taxes by Johnny Cash)

Dean Barber: That’s Johnny Cash, After Taxes, right? That’s what we all think about is, what are we going to keep after taxes? 

Bud Kasper: You know, I ran into him. 

Dean Barber: Did you?

Bud Kasper: I was at a Denver airport. I don’t know if I was skiing or something. Anyway, I went into a gift shop, and I was looking at some jewelry or something. All of a sudden, this shadow came over my right-hand shoulder, and as I made a slow turn to my right and continued to go up, because he’s a pretty tall guy, totally dressed in black, Johnny Cash right there. He was buying some sort of a Native American made bracelet for himself, so anyway, it was nice.

Dean Barber: What year was this?

Bud Kasper: Oh, gosh, I don’t remember.

JoAnn Huber: But he remembers meeting him.

Bud Kasper: Yeah, it was December. 

Dean Barber: Back in the day. 

Bud Kasper: Back in the day. 

JoAnn Huber: You don’t celebrate the anniversary every year? 

Bud Kasper: No. He went outside and got on his horse and ran and took off. That’s the last I saw of him. Johnny. 

Dean Barber: Oh, I didn’t know we were going to go down that road, but okay. It has nothing to do with taxes, but it’s nice to know that you met him.

Bud Kasper: Yeah. He’s from Texas. (sounding like “taxes”)

Dean Barber: I thought he was from Tennessee or something. 

Bud Kasper: No.

Dean Barber: I have no idea where Johnny Cash is from. 

Bud Kasper: I didn’t either, but I had to make it rhyme some way so. Okay. 

The Tax Cuts and Jobs Act & Charity

Dean Barber: Well, all right, so we’re talking about year-end tax planning strategies for 2020. We’ve talked a little bit about Roth conversions, RMDs, and the RMD age increase. 

Let’s talk a little bit JoAnn about how people are giving to charity now. One of the things with the Tax Cuts and Jobs Act. We get tax code changes to the standard deductions so that most people aren’t itemizing any more. Therefore, they’re not getting credit for their charitable giving as they did before. In a lot of cases, it’s not deductible unless you’re giving pretty sizable amounts.

JoAnn Huber: Right, and there is one little difference this year that, if you donate to charity, you can take $300 as a deduction as an above the line deduction, so you don’t have to itemize if you get that. 

Dean Barber: Oh, boy.

JoAnn Huber: It’s going to make a big difference.

Bud Kasper: Free $300, yeah.

Dean Barber: Look, honey, a quarter, pick it up.

Bunching

JoAnn Huber: They’re trying to encourage people to give to charity, but I think that’s just one of those little things to make sure people are reporting all of their charitable giving and taking advantage of it. Because even though it’s not much, it will make a little bit of a difference, but we want to look at the bigger picture and say, “How should you be giving your charity?” There are a few different strategies that we talk about depending on your age. If you’re under age 70 1/2, bunching of your charitable giving is one thing. 

What we mean by that is, by giving two or three years’ worth of charity in one year, so you take the standard deduction, the years you don’t give. Then the year you give that large deduction to charity, you take the itemized deduction, and there are different ways people can do it. 

Donor-Advised Funds

JoAnn Huber: Sometimes we’ll set up a donor-advised fund, which the benefit of that is, you get the deduction the year the money goes in. But then you can distribute the money out to the charity you want over multiple years.

Bud Kasper: If you’re planning and you knew that you had a tax event in one given year, bunching could help you?

JoAnn Huber: Right, so for example, say you get a really big bonus this year, and you want a deduction, but you don’t want to give it all to charity, you can set up a donor-advised fund and put the money in the donor-advised fund. Then in the next few years, you can just distribute it out to charity.

Bud Kasper: While getting that current year benefit?

JoAnn Huber: Yeah, so you get the large deduction this year to offset your income.

Practical Ways to Use Donor-Advised Funds

Dean Barber: Let’s talk about some practical ways to use that donor-advised fund, because let’s face it if you’re in the airline industry, if you’re in the foodservice industry, travel industry, anything like that, energy industry, you’re not going to get bonuses this year. 

So you’re not going to try to offset that, but if you know that you’re going to give to charity, and let’s say that your annual gifting is $5,000. All right, let me give ten years’ worth of my annual gifting to a donor-advised fund, so I’m going to put $50,000 in that. Now that $50,000 I get to use as a deduction the year that I put it in the donor-advised fund, right? 

JoAnn Huber: That’s right.

Dean Barber: Can I now take some of my IRA and convert it to a Roth IRA? Then have that deduction offset that conversion to get some of that money from my regular IRA to a Roth IRA without paying any taxes on it?

JoAnn Huber: You can.

Dean Barber: There you go.

JoAnn Huber: That’s the kind of thing we’re looking at.

Bud Kasper: Now that’s planning.

Dean Barber: There you go.

The CARES Act and Donor-Advised Funds

JoAnn Huber: You have to be aware that there are income limits on the amount you can take as a charitable deduction. But this year, another provision of the CARES Act is, they’ve increased the limits. So for a cash contribution, that wouldn’t apply to a donor-advised fund. Still, if you make cash contributions, you can deduct up to 100% of your adjusted gross income, so there are different planning opportunities.

Dean Barber: What’s the percentage if you do a donor-advised fund?

JoAnn Huber: It depends on what you’re donating.

Dean Barber: Say I’m donating stock.

JoAnn Huber: If it’s stock, it’s going to be 30% of your adjusted gross income.

Donor-Advised Fund Example

Dean Barber: Let me just give an example here, because I want to make sure that I get this, because if I can get it, hopefully, our listeners can get it, right?

Bud Kasper: That’s true.

Dean Barber: If I got $100,000 of income this year and I say, “I want to make a $50,000 donor-advised fund,” and then I go convert $50,000 from an IRA to a Roth. Suddenly, my taxable income would be $150,000, but 30% can be taken against the deduct or against the contribution to the donor-advised fund. So in that example, I can get my money from my IRA to my Roth IRA with no taxes due because I got to claim the full deduction for that $50,000 donor-advised fund.

JoAnn Huber: That’s the kind of thing that we have to look at is, what amount of income do you have to have? What amount do you need to give? Play with those numbers and see what gives you the best answer.

Dean Barber: Right, now I didn’t give the $50,000 away to charity this year. Remember what I did was, I put it into a donor-advised fund, and then I get to dole that out over ten years or however long I want to, to the charities of my choice. I can change my mind in the future. That’s tax planning, JoAnn, that’s what we’re talking about.

JoAnn Huber: Right, and that’s where we can make a difference. We can say, “What is it that you wanted to do?” Which is, you wanted to give to charity, and then how do we make it tax efficient?

Qualified Charitable Distributions

For those over age 70 1/2, we’ll look at qualified charitable distributions a lot of times. 

Dean Barber: Also affectionately known as the QCD. 

JoAnn Huber: There are all these acronyms.

Dean Barber: It’s so affectionate. 

Bud Kasper: Yeah, by the way, there’s a quarter on the floor next to you.

Dean Barber: This is another gift. This is another gift from Uncle Sam. Actually, this is a better gift than the $300 above the line deduction.

JoAnn Huber: Right. That one, it makes people feel good about themselves, right, but the QCD, I think, is right up there with the Roth conversions and different legislation that’s happened. It makes a big difference, especially with the higher standard deduction since few people are itemizing. The QCD benefit is people take money from their IRA and send it to charity. So like we use TD Ameritrade, and we’d contact TD Ameritrade, and they’d send the money directly to charity out of the IRA. 

Bud Kasper: Right. Got it.

The Benefit of QCDs

JoAnn Huber: The benefit of that is, you don’t have to include that in income, and so you don’t get to take the itemized deduction, the charitable deduction for it, but who cares?

Dean Barber: It’s better than that. 

JoAnn Huber: It is because it never hits your income. 

Dean Barber: Right. 

JoAnn Huber: And so…

Dean Barber: It can’t cause capital gains to be taxable. It can’t cause dividends to be taxable. It can’t cause more Social Security to become taxable. It’s better than the deduction.

JoAnn Huber: Right, it might help you with your Medicare premiums. 

Bud Kasper: And as Boomers continue to move past the age of 70, you’re going to have more of that opportunity in front of you.

Don’t Confuse Your RMD and QCD Age

Dean Barber: Now, don’t get confused because the RMD age is no longer the same as the QCD age. 

Bud Kasper: Right.

Dean Barber: They’re going to complicate this for you.

JoAnn Huber: Right. A common question this year is, well, can I still do a QCD since I don’t have an RMD? 

Dean Barber: Yes.

JoAnn Huber: You can. 

Bud Kasper: Yeah.

Dean Barber: But you have to be at least 70 1/2. You can’t do it at 70 years and five months and 29 days. You have to do it at 70 1/2. 

All right, here’s the thing, request a complimentary consultation by clicking here.

We can do that complimentary consultation in the office. We are doing that. Or we could do it through some kind of a virtual meeting, or we can do it via telephone. The important thing is that you start talking to us now about what you’ve got going on this year, but more importantly, what can we do for years to come to reduce the amount of money that you’re sending to Uncle Sam? It can be done, and the numbers are astounding. 

The “Original” CFP®

Dean Barber: I’m your host, Dean Barber, along with Bud Kasper and JoAnn Huber. Bud Kasper, the “original” CERTIFIED FINANCIAL PLANNER™.

Bud Kasper: The original?

Dean Barber: The original.

Bud Kasper: Yes. Well, and I knew Jesus when he first was born.

Dean Barber: Well, and Johnny Cash, as we now know.

Bud Kasper: What a dichotomy?!

Capital Gains and Phantom Income

All right. Capital gains. What do we have to do with capital gains before the end of the year?

Dean Barber: Well, here’s the thing. I call them, in years like this, phantom income. It’s income that can show up on your tax return, but there isn’t any gain to be seen.

JoAnn Huber: To clarify, we’re talking about capital gain distributions out of mutual funds.

Why “Phantom Income”?

Dean Barber: That’s right, mutual funds in volatile years. I think we agree we’ve had a volatile year. Most of the volatility occurred early in the year, back in March, but that volatility causes mutual fund managers to sell positions they may have held for years, which pushed the mutual fund share price. 

When they sell the underlying positions, that creates a capital gain on the stocks they held. Then at the end of the year, the mutual fund has to distribute that taxable gain. Now they don’t distribute it in the form of cash. It’s not the extra money made; it’s just distribution. Let’s say it’s a dollar per share distribution. Well, the share price drops by the same dollar the day they make the distribution. That’s why I call it a phantom gain.

So it’s possible if you bought some mutual funds at mid-year or even in the last two or three months, they might have some reasonably large capital gain distributions. You could have a capital gain distribution on that investment and not have a gain that looks anywhere near like the taxable consequences. Of course, we’re talking about taxable accounts only. 

Be Aware of Your Individual Accounts

So individual accounts, joint tenants with right of survivorship, joint tenants in common, trust accounts, etcetera. Those are the accounts you have to be cognizant of right now. Most mutual funds have already put out what their capital gain distribution estimates are. 

Some of them, the date you have to own the fund, the record date, to get the capital gain distribution, many have already passed. In many cases, there wasn’t a lot that to do this year, especially if you’d held it for a couple of years because you’re looking at pretty decent gains over two years with most equity mutual funds.

Bud Kasper: Absolutely.

Dean Barber: So, a 5%, 6%, 7% capital gain distribution is probably less than what you would realize if you sold that fund.

Bud Kasper: Right.

Tax Surprises You Need to Be Prepared For

Dean Barber: But, JoAnn, you’ve seen these things catch people by surprise, and they need to understand that they exist.

JoAnn Huber: I have.

Dean Barber: One of the downfalls of mutual funds in a taxable account, in my opinion.

JoAnn Huber: It upsets people when they are suddenly paying tax. And it’s like, “I didn’t make this much. Why am I paying taxes on this?” So it is that phantom income that causes a lot of grief.

Bud Kasper:That has to be noted. The advisor should make the recommendation and should know because they give you a pretty good idea as to what the distribution is going to be.

JoAnn Huber: Right, but you have to look at it. You never want to make an investment decision based on taxes. Taxes are one piece to consider, but you need to look and say, “Okay, does that holding fit into my overall investment portfolio?”

Bud Kasper: True.

It’s Not So Simple

JoAnn Huber: And do I want to keep it? Is there a purpose it’s serving, or do I want to sell it to avoid the capital gain distribution? And if you sell it, what’s going to be the tax impact of that?

Bud Kasper: Exactly.

JoAnn Huber: So it’s not just as simple as saying, “Oh, there’s this capital gain distribution. I need to get rid of it.”

Bud Kasper: And there’s that gray area in between. Yeah, I could do it. Yeah, I save a little bit in taxes, but is it worth losing the potential? Because if you sell it, then you can’t buy it back for 30 days. So we have that issue as well.

JoAnn Huber: Yeah. There are many things to consider, and you can’t look at any one of them alone. It needs to be looking at everything together.

Dean Barber: So let’s talk briefly. We did this in detail on The Guided Retirement Show™, our podcast. It was in season one. It was all about mutual funds versus ETFs. It’s episode 12 and 13 of The Guided Retirement Show™ in season one, and you can find it on your favorite podcast app or YouTube, or here. 

Mutual Funds, Not ETFs

I want to clear something up here because we’re talking about mutual funds and not exchange-traded funds. The exchange-traded funds typically don’t have the turnover of the stock because they’re trying more to track an index. So most of the ETFs are going to be more tax-efficient inside of a taxable account than a mutual fund would be. JoAnn, would you agree with that?

JoAnn Huber: I would agree entirely with that, and that’s why it’s so important to make sure you’re holding the right things in the correct type of accounts.

Dean Barber: Right.

JoAnn Huber: You know, where should you be holding your ETFs?

Bud Kasper: That’s excellent advice.

JoAnn Huber: Where should mutual funds, the bonds? And that’s an essential part of tax planning.

Dean Barber: We call that asset location.

Bud Kasper: Yeah. I’m afraid so many people out there are using a person to help them with their investment solutions. However, they’re not considering the importance of taxation on the net result of their investment.

Taxes Aren’t Many Advisors’ Expertise

Dean Barber: Well, let’s face it; there are many people in the investment world, Bud, that taxes are not their expertise. And unless you have a team of CPAs as we have with JoAnn and her team here, they don’t know. That’s not their expertise! They’re looking at the investment, and if they think that investment is the right investment, they’re saying, “Well, if you want to understand the tax consequences of it, go talk to your CPA.” 

Well, if the CPA doesn’t know what the investment advisor is doing, all kind of translation gets lost, and that’s where people wind up having bigger tax bills than what they should. And we see it happen all the time when people come in to visit with us for the first time.

Bud Kasper: Right. The critical element is not that you had a tax advantage necessarily at that moment in time. It’s the benefit that you get the next year, the following year, and so on. That’s how we compound that into an incredible planning opportunity.

JoAnn Huber: Yeah. That’s where I feel fortunate that we do work as a team. We can have that conversation with the advisor and say, “Do you realize what’s happening from a tax standpoint from this? And is there something else that we can do?” Then, they can share with us what’s going on. 

Communication is Critical

It’s essential to have that communication because otherwise, I think it goes back to that game of telephone. If you have that person being the intermediary, they often don’t know what’s said, or maybe it’s just one word that’s different, but that can be a significant difference. 

The impact of that one word can have a significant effect on your taxes. So everybody must be communicating and working as a team to help you keep your money. I mean, when we’re talking about tax planning, we’re looking at how do you maximize the amount of money you get to keep.

Dean Barber: So, JoAnn, you bring up an excellent point. So everybody listening, I want you to think about this for just a minute. When was the last time that you sat down and in the same room, you had your investment advisor, your CERTIFIED FINANCIAL PLANNER™, your CPA, your risk management person, and your estate planning attorney, all listening to what you want to have happen with your financial life? When was the last time that happened? For the majority of you, it’s never happened. 

The ultra-wealthy people in the United States, they expect that. The mass affluent, those of you out there, the millionaire next door, not only do you not expect it, you don’t even know it exists, but it does. And it’s right here at Modern Wealth Management. 

We’re Here to Help

Let us show you with a complimentary consultation, how we can, with our team of CPAs, financial planners, estate planning attorneys, risk management experts, bring clarity to your financial life in such a way that you feel confident and in control of everything. And in a big way, JoAnn, the tax part of that plan is the hub, right? Because everything comes off of that. Get that complimentary consultation by clicking here.

JoAnn Huber: Right. It goes back to what you said earlier in the show, every financial decision has a tax impact at some point.

Dean Barber: We appreciate you joining us here on America’s Wealth Management Show. We’re ready to say goodbye to 2020 too, but we still have a few weeks left. So hang in there. I’m Dean Barber, along with JoAnn Huber and Bud Kasper. We’ll be back with you next week. Same time, same place.