Taxes in Retirement with Steven Jarvis
Taxes in Retirement with Steven Jarvis Show Notes
As many Modern Wealth Management clients have come to realize, it’s critical to have a CFP® Professional and CPA working together on your financial plan. That collaboration is key so that nothing gets overlooked within your plan from a tax planning perspective. Our tax team has long been committed to forward-looking tax planning, not only during tax season, but year-round. They’re looking forward to building upon that commitment and analyzing the impact of taxes in retirement now that we’ve formed a strategic partnership with Retirement Tax Services.
In this episode of The Guided Retirement Show, Retirement Tax Services Head CPA and CEO Steven Jarvis shares what his company is all about, and how he’s in full agreement with our form about the importance of CFP® Professionals and CPAs collaborating to do what’s in the best interest of the clients.
In this podcast interview, you’ll learn:
- Why it’s crucial to create tax diversification.
- That the tax code can be a little less complicated with professional help.
- Why the SECURE Act is secure in name only.
- How to avoid “tipping the IRS.”
- Why Modern Wealth Management and Retirement Tax Services are so passionate about tax planning.
- “I realized early on that taxes should be a passenger on the bus, not the driver. It’s just one piece of the puzzle. We’ve got to include it in a proactive and intentional way in the rest of the plan.” – Steven Jarvis
- “A lot of people think that if they’re going to do tax planning that they need do it before they retire. No. It’s through your entire life that you need to do tax planning.” – Dean Barber
- Tax Planning Strategies with Marty James
- Ed Slott In-Studio!
- Creating a Tax-Free Retirement with Ed Slott
- Optimizing Your 401(k) for Retirement with Drew Jones
- Modern Wealth Management Educational Series
- America’s Wealth Management Show
- Our Financial Planning Tool
Interview Transcript – Taxes in Retirement with Steven Jarvis
Introducing Retirement Tax Services Founder and Owner Steven Jarvis
[00:00:47] Dean Barber: Hello, everybody. I’m Dean Barber, Managing Director at Modern Wealth Management and your host of The Guided Retirement Show. I have a very special guest with me today in Steven Jarvis. He’s the head CPA and CEO of Retirement Tax Services. We recently formed a strategic partnership with Steven and his team at Retirement Tax Services. Today, we’re going to talk about taxes in retirement and the importance of why your financial advisor should be collaborating with you and the CPA all at the same time.
Before we hop into today’s episode, I want to remind our listeners and viewers that you can access the same financial planning tool that we use for our clients at no cost or obligation. You can begin building your plan on your own time and from the comfort of your own home with our tool by clicking the “Start Planning” button below. Please enjoy my conversation with Steven Jarvis, Head CPA and CEO of Retirement Tax Services.
What Is Retirement Tax Services?
[00:01:47] Dean Barber: Steven Jarvis, Head CPA and CEO of Retirement Tax Service. Welcome to The Guided Retirement Show.
[00:01:53] Steven Jarvis: Thanks for having me, Dean. I’m excited to be here.
[00:01:55] Dean Barber: It’s interesting because Retirement Tax Services has something in common with The Guided Retirement Show. They both have the word retirement in it. Why do you call it Retirement Tax Services? Why is that the name of your company?
[00:02:10] Steven Jarvis: There are a few things that go into that. One of the big things is that we kind of made up this term of retirement tax at Retirement Tax Services. Most people don’t recognize that during their retirement, the IRS still wants a piece of what they have. So, we put it around this term of retirement tax. It’s the six-or seven-figure bill that you are going to pay the IRS over your retirement. We look at it that way because we want to have long-term conversations. We want to help people plan ahead and reduce the amount of tax they pay over their lifetime.
[00:02:48] Dean Barber: All right. We have formed a strategic relationship together with Steven and Retirement Tax Services. I’ll call us business partners because we do things in common for our clients. You have a very strict rule. Retirement Tax Services won’t do a tax return for anybody that is not currently working with a financial advisor. Talk more about that and why you think that’s critical.
Taxes Should Be a Passenger on the Bus, Not the Driver
[00:03:09] Steven Jarvis: So, I’m a tax professional. You said it. I’m a CPA. I care very much about the tax. That’s my area of expertise. But I realized early on that taxes should be a passenger on the bus, not the driver. It’s just one piece of the puzzle. We’ve got to include it in a proactive and intentional way in the rest of the plan.
What I’ve found to be the most beneficial to the taxpayer, to the client, is to have somebody in their life who’s looking through the rearview mirror—looking at what happened, looking at what’s on the tax return—and through the windshield to see what’s coming next, whether it’s tax related, investment related, risk management, etc. Somebody needs to be looking out for both those things. And sometimes that requires multiple professionals. That often includes both a financial planner and a tax professional, so why not have them collaborate?
[00:04:00] Dean Barber: They should. I know this from being a financial advisor for 35 years. I don’t know how long Steven has been a CPA, but it’s been more than 10 years. There are pretty much no decisions from a financial perspective that somebody makes that don’t eventually wind up on the tax return.
Creating Tax Diversification
Steven uses this term retirement tax, and I kind of like that. I hope people don’t think that it’s a separate tax. It’s just the tax you must pay in retirement. Steven is right. Taxes will be a fact of your life in retirement, but you really have more control over your taxes in retirement than any other time in your life if you’ve done a good job of creating tax diversification.
Click Here to Read More
[00:04:53] Steven Jarvis: Creating tax diversification is important. If we just kind of let things happen by default until retirement, we run out of the ability to make choices at that point. It’s how we set ourselves up to get there.
So, when we named our firm Retirement Tax Services, it wasn’t because we only work with people who are in retirement. It’s because we want that long-term mindset. There are so many proactive choices that we can make that set us up for that flexibility in retirement because for most people taxes will end up being the single largest expense they have during retirement. It’s either taxes or medical expenses. It’s a big one and people don’t realize it a lot of times.
The Tax Code Is So Darn Complicated
[00:05:32] Dean Barber: Taxes are the number one wealth eroding factor facing Americans. Our tax code is so complicated. It was 76,000 pages before some of the new things that have been tacked on. It’s probably over 80,000 pages now. I always tell people that if you ever want to win a game, you’ve got to know the rules to the game. But how can the individual be expected to understand the rules that Congress has given to the IRS to enforce? A lot of times the IRS doesn’t even know how to interpret what Congress wrote.
[00:06:09] Steven Jarvis: You’ve got me, Dean. Congress doesn’t ask for my input on what the tax rules should be. I gave up a long time ago trying to find the logic in tax rules. There isn’t any. Most tax rules are about behavior and votes. It’s not even about revenue, so stop trying to find the logic in it.
Understanding the Rules of the Tax Game
To Dean’s point, you need to understand the rules of the game. There are some people who do a fine job of preparing their own taxes. I always get a little bit nervous that something is going to change and you’re not going to realize it. Not that there’s anything inherently wrong with doing your own taxes, but make sure there is somebody in who can watch out for those road markers.
[00:06:48] Dean Barber: Right. But even more important than that is people don’t understand that the tax implications of the decisions that they make throughout the year.
For example, say that you’re buying a new car. Someone might think that they can just cash out an IRA and use that money to buy the car. They didn’t talk to a financial advisor because they don’t have one. They didn’t ask their CPA where they should get the money from or they just put that in if they’re doing their own taxes. Guess what they just did to their retirement? They just made a lot more of their Social Security taxable. They made their Medicare premiums go higher because they took the money from the wrong place.
The Tax Game Rules Change in Retirement
All kinds of things go bad. The rules of taxes change in retirement because you have Social Security, which is taxed differently than any other asset. You have dividends. You have capital gains that are tax free up to a certain level. They can get messed up and start to become taxable by taking too much out of your IRA in a given year.
I know that Steven has seen this as a CPA. Let’s say that someone is in the 22% tax bracket and plans to take some money out of their IRA. They take $20,000 out thinking that they’re going to pay $4,000. What they didn’t realize was that that $20,0000 caused $15,000 of Social Security to become taxable. And that $15,000 of taxable Social Security started causing dividends and capital gains to become taxable. Suddenly, they’re paying 45% tax. They’re like, “What just happened?”
[00:08:24] Steven Jarvis: And Dean is only talking about the federal level. We’re not even getting started on the state level.
[00:08:27] Dean Barber: It’s complicated and convoluted. The reason I was going down that path is because I don’t think people understand how critical it is to collaborate with their CPA and CFP® Professional before taking money out of any account. They need to talk with them to determine their best option.
[00:08:53] Steven Jarvis: Most Americans have been W-2 employees for a lot of their career. They’ve done a great job saving, accumulating for retirement. Even as a business owner, the dynamic changes with taxes when you retire. People just aren’t aware of how that dynamic works after they retire.
The IRS Isn’t Patience When They’re Going After Their Piece of the Pie
It comes as a surprise for a lot of people that Social Security is even taxable to begin with. We go from this environment where we get a paycheck, a distribution from our business, pay taxes on it and move on. That’s all connected to us.
But suddenly we realize that some of these other things that happen with powerful tools for retirement like your 401(k), your IRA. We still need to understand that the IRS is only so patient. And when you retire, their patience suddenly runs out and they want their piece of that. It catches a lot of people off guard.
An Irreversible Financial Mistake
[00:09:45] Dean Barber: It really does. For example, let’s say that somebody took money out of an IRA in retirement. They didn’t realize it was going to cause more of their Social Security to become taxable. They didn’t realize it was going to cause some of those extra dividends to become taxable. Since they took it out, they can’t get it back in. It’s an irreversible financial mistake.
Most people that aren’t coordinating with a CPA and a CFP® Professional together are most likely overpaying their taxes. They’re not overpaying their taxes because the tax return was done improperly. They’ve overpaying their taxes because they’ve missed opportunities that they didn’t even know existed.
[00:10:33] Steven Jarvis: One of the biggest things I work with taxpayers and financial advisors on is breaking away from this idea that tax time is April. That might be when the tax filing deadline is, but we should be talking about taxes year-round.
Don’t Tip the IRS
That reinforces what Dean is talking about with the power of collaborating between financial advisors and tax preparers. As we have those conversations year-round, we can start making better decisions about where we take money from and when to recognize income. If we wait until March or April to talk to our tax preparer and say hey about what you did last year, your opportunity for decision making is over. If you’re proactively thinking about that in May, June, or July, you can make those decisions and stop overpaying the IRS.
[00:11:18] Dean Barber: What do you and your team at Retirement Tax Services call that? Don’t tip the IRS?
[00:11:22] Steven Jarvis: There are no patriotic awards for paying the IRS. Tip your server, not the IRS. That’s the way we like to say that.
What to Think About When Claiming Social Security
[00:11:30] Dean Barber: Let’s talk about some of the ways that you can really help by being that tax professional working alongside the financial advisor. We’re painting some very broad brushstrokes about how it can make a difference. But if I’m looking at a client’s situation and they’re going to retire this year and they’re 62, one of the decisions that they need to make is when to claim their Social Security. A lot of people think that Social Security claiming is synonymous with the date that you retire, especially if you’re of that age where you can start claiming it.
I think the Social Security claiming decision is twofold. Number one, it’s a tax decision. It’s a huge tax planning decision because it can mess up the ability to do some creative tax planning and it’s a decision that’s going to impact not just the married couple, but the surviving spouse as well. Let’s talk a little bit about how you would look at when somebody should claim their Social Security.
[00:12:44] Steven Jarvis: Again, it highlights the power of collaborating between the two professionals. As a tax professional, I love being part of that conversation. However, I’m not going to give the final recommendation to a client because there are those other things that get involved.
Making Decisions Based on Your Future Tax Bracket
But from a tax perspective, we want to look for ways that we can create flexibility in our decision making as it comes to taxes. Our biggest opportunity with the IRS is understanding whether you’re going to be in a lower or higher tax bracket in the future. And then you decide whether to move up or delay some income.
Do you want to move up or delay some expenses? By looking strategically at when to claim Social Security, you can potentially create a few years for yourself between retirement and claiming Social Security where your income is suddenly lower than it’s ever been when you were working and lower than it’s going to be when you claim Social Security or start taking Required Minimum Distributions.
Now, you’ve created this window where you can recognize capital gains at 0% tax. You’ve created an opportunity where you can get money out of an IRA in the 10% or 12% bracket instead of the 22% bracket, 24% bracket, or higher brackets.
[00:13:55] Dean Barber: You can do that and do a Roth conversion.
Creating Financial Flexibility
[00:13:57] Steven Jarvis: Yeah. You’re creating this flexibility where you have some years where you’re putting off when you might claim Social Security, which is going to impact how much you get. And if you can delay that, you’re going to get more. More importantly, you’re creating some years of flexibility. That might make sense for some people and might not for others. But you should certainly go through the evaluation.
[00:14:16] Dean Barber: And just going back to the fact that pretty much any financial decision you make is going to have an impact on your tax return. It’s going to show up there at some point.
How Secure is the SECURE Act?
Think about when people are in their peak earning years. They’re generally in their mid to late 50s, early 60s. You’re making more money then than you’re ever making in your life and suddenly, the IRS comes out with this new rule they call the SECURE Act. I think the acronym actually stands for setting every congressperson up for retirement enhancement. This act was one of the biggest money grabs that I’ve ever seen Congress pull. It’s totally opposite from being secure.
The reason I bring it up with that person that’s in their peak earning years is because that’s the person who is the most likely to inherit an IRA from their parents. Their parents are in their late 70s or 80s. That’s when people start passing away. People think their kids are going to get their IRA and that their kids are not going to be in as high a tax bracket as they are.
Tax Planning Isn’t Just for Retirees
Well, look at the people that are inheriting money. It’s not the 15, 20, and 30-year-olds. It’s the 50 and 60-year-olds that are in their peak earning years. With the SECURE Act, all that money is probably going to be forced out of that IRA at the highest tax bracket that there’s ever been. And they never would have paid that had they done some proactive tax planning. A lot of people think that if they’re going to do tax planning that they need do it before they retire. No. It’s through your entire life that you need to do tax planning.
[00:15:53] Steven Jarvis: I completely agree. Whatever age you are, if you are filing a tax return, there is tax planning we can do. Whether you are 18 or 80, it’s going to change over time. There is not going to be quite as much I can do with an 18-year-old. But I can set them on the right path. If you’re filing a tax return, we can absolutely do tax planning at any point.
Inherited IRAs Can Involve Tricky Tax Situations
The SECURE Act is a great example of the power of tax planning because what Dean was alluding to. One of the biggest things that it did was force people to have a much shorter time window if they inherit an IRA. They need to distribute it, which means the IRS gets a cut.
What I see quite often is that people will inherit that IRA and just assume that they need to transfer that to different accounts and distribute the whole thing. They assume that because no one has told them any better.
Now, they’ve taken an entire lump sum in one year and they pay taxes at the highest possible rates. They get killed in taxes, absolutely killed. Even though the SECURE Act shortened the window where you need to do that, there are still opportunities to plan if you’re proactive. That planning can help with avoiding that huge distribution and paying all the taxes.
Studying with Ed Slott, America’s IRA Expert
[00:17:00] Dean Barber: Steven is making me chuckle. Part the the way I got to know about Steven and Retirement Tax Services was because he also knows Ed Slott, who is a good friend of mine. I’ve been studying with him for years. During our meeting back in the spring, he went through a private letter ruling where a father died, the mother had already passed, and their two boys inherited the money. These two boys happened to be in their 40s. There was a couple million dollars in the IRA and these two boys immediately wanted to start trading stocks in the IRA.
Well, the custodian or the financial institution where the money was held didn’t allow stock trading. These boys, not knowing what they’re doing, took the entire $2 million out of the father’s IRA, opened another account, and started trading stocks. They were really surprised that they had to pay taxes on that entire $2 million in that year. So, they filed for a private letter ruling, claiming that they didn’t know that that was going to happen. They inherited the IRA, but they didn’t do it right.
The 10-Year Rule with Inherited IRAs
[00:18:15] Steven Jarvis: The question that you need to ask is do you have an inherited IRA or did you inherit an IRA? That might sound like a small distinction, but this is exactly what we’re talking about. Did you get a whole bunch of money and have an inheritance or did you actually keep it in an IRA so you’ve got this 10-year window to do something about it?
[00:18:35] Dean Barber: Those rules are super strict when it comes to inheriting an IRA. If you mess one of them up, chances are very rare that you’re going to get any kind of sympathy from the IRS because they say their rules are clear.
[00:18:47] Steven Jarvis: That’s debatable but that is their opinion that their rules are clear, and complete ignorance doesn’t help anyone. It’s a fascinating sort of industry in that the tax code is 80,000-plus pages, yet your everyday consumer is expected to file their own taxes and understand all that. It’s nonsense.
[00:19:06] Dean Barber: Right. Well, there’s a program.
[00:19:08] Steven Jarvis: There’s a program. If it goes through software, it must be perfect.
When Is It Time to Start Getting Some Professional Help with Taxes in Retirement?
[00:19:11] Dean Barber: Steven uses a program, but he’s a professional looking at all the different nuances that understand the rules. If you change one thing over here, it could have a more favorable outcome over there. If you make this mistake, it could have a less favorable outcome. You can play that scenario. And some people can use this. The free tax returns, right?
Steven and I were kind of joking about that at dinner the other night. Yes, the tax preparation might be free, but what did it cost you? Unless all you had was a $30,000 W-2 and you had no dividends, no interest, no IRA contributions, then you’re fine. But for somebody who is in their 40s, 50s, 60s that’s accumulating some money, more than just a couple of W-2s, it’s time to start getting some professional help.
[00:20:18] Steven Jarvis: Yeah, absolutely. I love software, but one of the common myths about taxes that I really try to break down is this idea that if it went through a software program, it must be right. But that’s just not the case.
How Do You Win Against the IRS?
I like the software platform that I use. It’s a great tool, but that expertise still needs to be there. Think back to the last time you used one of the free platforms. Most of what they’re doing is steering you toward trying to get the biggest refund right now as possible. While refunds might feel good when you get them, that is not how we win against the IRS. A refund is just the IRS giving you your money back after they took an interest-free loan from you.
It’s created this mentality for a lot of taxpayers that as long as you get a refund, you must be winning. I’ve worked with taxpayers who will tell me, “I got a $5,000 refund. I’m doing so great.” Then I’ll tell them, “The IRS kept $80,000 of your hard-earned money last year. But they’re so focused on the $5,000 refund that they don’t know what I mean by that. They’re getting that “refund” because they paid the IRS $85,000, but only owed $80,000. A lot of people have no concept of how much of their money the IRS is keeping.
[00:21:29] Dean Barber: What would cure that is if you had to write the IRS a check every month just like you do with your mortgage, health insurance, or whatever. That would change everybody’s attitude when it comes to taxes.
Don’t Forget About Uncle Sam
In retirement, guess what happens? You’re writing that check every quarter. You’re estimating what you’re going to owe. Someone might think that they have $1 million in their IRA just from looking at their statement. Your statement says you have $1 million, but you have a partner in that account. That partner is Uncle Sam. Go try to take that $1 million and go spend it. You can’t spend $1 million because it’s not all yours.
[00:22:06] Steven Jarvis: That’s a good point. I think that’s why a lot of business owners are a little bit more likely to talk about tax planning earlier in their careers because they need to write that check to the IRS.
A Misconception About Tax Planning
A lot of W-2 employees just aren’t as aware of it. But there are still tax planning opportunities for those individuals. I hear a common refrain of, “Well, business owners have more opportunities for tax planning.” Maybe, but they just have different opportunities. Like I said before, anyone who is filing a tax return has tax planning opportunities. But we’ve got to have that context of understanding.
Do you know much of your money the IRS kept last year? Go double check yourself and then decide if you think you need a tax professional.
Tax Planning 101: Contributing to the Roth or Traditional Part of Your 401(k)
[00:22:49] Dean Barber: We talked about a lifetime of taxes and how taxes will be a fact of life. Here’s a simple form of tax planning to keep in mind. Should you be making contributions to the traditional or Roth part of your 401(k)? Well, that’s not a question that can be answered until you fast forward into the future. What do we project that your net worth is going to be when you retire and start spending these funds?
What do we think the tax rates are going to be at that point? Then, we can come back and do a calculation. If you did some in Roth, some in traditional, this is going to give you this.
It wasn’t too long ago that the Roth 401(k) became available, so there are still people that don’t completely understand it. I’ll see that people in their 50s and in peak earning years are cramming all their contributions into the Roth portion of their 401(k) when they come in and meet with one of our sit down with one of our CFP® Professionals.
When you complete the financial plan, you realize when they get into retirement that they only need $10,000 a month to live. But they’re earning $300,000 a year today, so they’re in a much higher bracket. I would say they’re making a mistake.
They shouldn’t be making contributions to Roth. They should be making contributions to their traditional side and getting the tax deduction at that higher rate. Then, get into retirement and do what we talked about earlier by starting to convert some of that money. Now, you get to arbitrage and start winning a little bit of the game.
Tax Brackets Are Likely Going Up in the Near Future
[00:24:34] Steven Jarvis: You’re exactly right. It’s only over time that we can come out ahead against the IRS. Do you think you’re going to be in a higher or lower tax bracket now compared to what you’ll be in in the future?
[00:24:44] Dean Barber: Lower.
[00:24:45] Steven Jarvis: For most people right now, we’re pretty confident that tax rates are going to go up. Whether it’s the sunset of the Tax Cuts and Jobs Act or all the nonsense that Congress constantly talks about, I think there’s a pretty good chance that we’ll all be in higher tax brackets in the future.
[00:25:01] Dean Barber: Steven does a podcast and writes a lot of content with Retirement Tax Services. People reach out to him and are complimentary of what he’s doing. And in many cases, they ask him to help them with their taxes. Steven, what is your response when they ask you about that?
Adding Real Value to Someone’s Financial Life Through Tax Planning
[00:25:21] Steven Jarvis: I’m more than happy to if they’d like to get partnered up with an advisor who also works with us. There’s just so much power in that collaboration. And I don’t want to compete with H&R Block for who can do the most 1040s in the year. I want to have a real impact on people. I want to add real value through tax planning along with the necessity of filing a tax return. I’m only working with only working with taxpayers who have an advisor who’s willing to collaborate with me.
[00:25:47] Dean Barber: I think that’s a beautiful thing. We’ve had CPAs in-house here, but we wanted to expand what they can do through tax planning by starting this strategic partnership. Retirement Tax Services has some bandwidth, so it’s super exciting for us to be partnered together with Steven and his team.
Making a Necessary Service More Valuable
There are not a lot of CPAs who get the impact of the long-term tax plan, but you do. Back in the day when Ed Slott was getting trained, the whole objective was to do the tax return and see how big of a refund you can get a person that year. They would never say, “Look into the future and see how we can impact into the future.” That’s how most CPAs still operate.
[00:26:39] Steven Jarvis: CPAs and world agents—whatever tax professionals you’re working with—their focus is primarily that rear-view mirror. And they are providing a necessary service.
[00:26:48] Dean Barber: For sure.
[00:26:49] Steven Jarvis: Nobody wants to get those love letters from the IRS. Usually, I refer to them as nasty-o-grams. Nobody wants those. They’re providing a necessary service, but where it becomes a valuable service is where we combine looking at what happened last year with what can we do in the future.
[00:27:05] Dean Barber: And it’s hard to say what can we do in the future unless you’re working with a CFP® Professional that says this is this person’s objectives. These are all the places where they’re saving money because where they’re saving money doesn’t necessarily show up on the tax return.
Taking Taxes in Retirement Seriously at Modern Wealth Management and Retirement Tax Services
[00:27:18] Steven Jarvis: And I certainly share that excitement for our strategic partnership. For me, in part, it’s because there are many financial advisors who don’t take the tax return seriously enough. It’s a little bit surprising and somewhat concerning to me with how many advisors make recommendations to their clients that have a tax impact. But they’re making these recommendations without ever having looked at the client’s tax return or having talked to a tax professional. Anything to do with money is going to have a tax impact.
That’s where my excitement comes from in us partnering together. Dean and his team were already really committed to the tax aspect. So, I know it’s going to be a collaboration because it must go in both directions. There are plenty of things tax preparers need to do different. I’m also on a personal crusade to help as many advisors as possible realize that if they want to be responsive and provide value to their clients, they need to be getting tax returns. They need to incorporate that. That’s something Dean and his team have been doing for years.
[00:28:12] Dean Barber: You can’t even do a financial plan if you don’t have a tax return. It’s impossible.
[00:28:18] Steven Jarvis: Not a good one anyways.
Always Look Ahead for Opportunities
[00:28:19] Dean Barber: Well, nothing of any quality. All right let’s give a couple of freebies here. Obviously, we can’t give advice because to give advice, we meed to know a person’s overall situation. But we do know of a couple of things that are happening this year that people should be looking for and taking advantage of. So, even if somebody decides that they don’t want to hire a financial advisor or CPA, I want to give them a little bit of value with this podcast.
The two things I’d like to speak on briefly are the high potential for phantom income coming out of mutual funds in a taxable account this year and tax-loss harvesting.
Keeping an Eye Out for Phantom Income
Let’s first talk about the phantom income that can come out of mutual funds in a taxable account. We had a roaring stock market and now the stock market is not doing so well. It’s up and down. A lot of fund managers have turned over the positions inside their mutual fund. That’s going to create a problem.
[00:29:30] Steven Jarvis: Definitely. For a lot of us, we look at our account statements to determine what has happened this year. The way it works is that we buy and sell stocks. Even if you own mutual funds, underneath those mutual funds are a bunch of stocks and other assets and positions. They might have been accumulating value for years. Some of those over their lifetime or the lifetime that you’ve owned them might be in a gain position even though they’re down this year.
Paying Taxes on an Account That Lost Money?
So, you’re seeing on your statement that you’ve lost a bunch of money and are thinking that you can’t possibly have to pay taxes on that money you lost. But in that turnover that Dean was talking about, there could have been some gains that have accumulated for years. When those fund managers turn those over and create those gains, they need to distribute those capital gains. A lot of people could end up with taxable income for accounts that lost money this year.
[00:30:23] Dean Barber: It seems totally counterintuitive. You almost need to draw it out on a piece of paper for people to understand how it works. Anybody that owns mutual funds in any kind of a taxable account—whether it’s a joint account, trust account, individual account—you need to get hold of the mutual fund company.
If you’re working with a good advisor, they should already be doing this. Find out what kind of embedded gains are in those funds. You need to find out the potential capital gain exposure for this year. You also need to find out your cost basis for that fund. It might be that you still have a little bit of gain in that position because you’ve held it for a year or several years. But the capital gain could be larger than what your actual gain in the position is. So, it might be smarter to sell that gain before the capital gain distribution takes place.
Why Tax-Loss Harvesting Makes Sense in a Down Market
[00:31:19] Steven Jarvis: That reinforces that most of us are going to get to a point in our life where it makes sense to work with a financial professional. There might some people trying to follow along with our conversation that got lost halfway through. That’s why there’s such an advantage to working with a financial professional who can help identify these things and a tax professional who can make sure it ends up on your tax return.
[00:31:38] Dean Barber: Definitely. The stock market has been all over the place this year. A lot of technology stocks are down 40%, 50%, 60%. The NASDAQ at one point was down over 30%. Who knows where it’s going to wind up by the end of year. There is a tax strategy called tax-loss harvesting. Talk about tax-loss harvesting and why that makes sense.
[00:32:00] Steven Jarvis: This comes back to making decisions when they’re available to us under the tax code. We talked about how those investments we have become taxable, and when there’s activity when we sell them. Even though they might be in a loss position, we can go ahead and intentionally sell a position at a loss and go back and buy a similar position to get back into it. It can’t be the same one. That’s the wash-sale rule. To recognize a loss to offset gains that we have, we want to be strategic about this with how it fits into our overall plan. This is not the kind of thing that everyone should do just because you heard about it on a podcast.
Harvesting Capital Gains
But there’s the potential advantage of offsetting other gains or other income to lower our taxable income. You can create this tax benefit even though we have other losses. I always like to highlight that this also works in another way as well. We can harvest capital gains. This goes back to understanding where we’re at with our income now versus in the future.
There is opportunity at times to recognize capital gains at a 0% tax rate. When I’m working with clients, I look at both. Do we harvest capital losses? Those are going to be a little more relevant in a year where everything is down. But also, can we strategically recognize capital gains?
[00:33:15] Dean Barber: If you can strategically recognize a capital gain and you’re in the 15% bracket at this point, there’s zero tax on a capital gain.
[00:33:25] Steven Jarvis: If your ordinary income is in the 15% bracket, then your capital gains income is most likely going to be 0%.
[00:33:30] Dean Barber: There are a lot of things that people need to be doing. I just thought we ought to give a couple of freebies away.
A Couple of Differences on 2021 Tax Returns vs. 2022 Tax Returns
[00:33:36] Steven Jarvis: There are two other things I’d quickly highlight. They might not be as applicable to everyone, but it might be for some people, and that’s just the differences from 2021 to 2022. In 2021, a lot of people received COVID stimulus checks. Those didn’t happen again. A lot of people didn’t realize that that lowered their tax bill because that’s how it was sent out was as a tax credit. So, if you got a big refund last year and that was part of why, you might be in for a surprise this year when your refund is lower.
It’s the same with the child tax credit. Child tax credits were temporarily a lot higher in 2021. Those are going back down in 2022, so it’s a great reminder to make sure you’re planning ahead so you don’t have any nasty surprises come April.
[00:34:16] Dean Barber: As good as it might feel for somebody to get a little bit of refund, the last thing they want to do is have to write a big check.
[00:34:21] Steven Jarvis: I completely agree.
Collaboration to Help Your Tax Situation and Overall Financial Plan
[00:34:23] Dean Barber: Well, Steven, thanks so much for taking the time to be here on The Guided Retirement Show. I’m looking forward to the partnership, collaboration, and the ability for us to truly change the way that people look at their overall financial plan and tax situation and save them a ton of money over time.
[00:34:39] Steven Jarvis: Absolutely. I’m here to help as many people as possible stop overpaying the IRS.
[00:34:42] Dean Barber: Super. I hope you enjoyed my conversation with Retirement Tax Services Head CPA and CEO Steven Jarvis. And I hope you can see at this point why it’s so critical that you work with a CPA and a financial advisor that can collaborate on your behalf. Don’t forget we’re offering you access to the same financial planning tool we use for our own clients. Just click the “Start Planning” button and begin your retirement plan from the comfort of your own home.
As Steven mentioned, there were a number of instances in our conversation where people probably had some questions. Well, we’re more than happy to answer them. If you have any questions about taxes in retirement, our partnership with Retirement Tax Services, or how to start building your financial plan, you can visit with one of our CERTIFIED FINANCIAL PLANNER™ Professionals. Just click here to schedule a 20-minute “ask anything” session or complimentary consultation with one of our CFP® Professionals to gain the clarity and confidence that’s needed to live your one best financial life.
Sign up for our weekly newsletter which includes educational articles, videos, and more. It arrives in your inbox every Tuesday morning to keep you up-to-date.
Investment advisory services offered through Modern Wealth Management, Inc., an SEC Registered Investment Adviser.
The views expressed represent the opinion of Modern Wealth Management an SEC Registered Investment Advisor. Information provided is for illustrative purposes only and does not constitute investment, tax, or legal advice. Modern Wealth Management does not accept any liability for the use of the information discussed. Consult with a qualified financial, legal, or tax professional prior to taking any action.