How Do You Approach Pivoting a Client's Retirement Strategy Due to Tax Law Changes?
When tax laws shift, financial professionals must adeptly navigate the new landscape to safeguard their clients' retirement futures. A CPA emphasizes the need to personalize retirement strategy adjustments, while we also present additional answers that range from optimizing Roth IRA conversions to diversifying with tax-efficient index funds. These insights, including those from industry experts and seasoned financial planners, provide a spectrum of strategies to pivot retirement planning effectively.
- Personalize Retirement Strategy Adjustments
- Stay Informed and Model Outcomes
- Consider Who, What, Where, When, Why
- Optimize Timing for Roth IRA Conversions
- Increase Tax-Deferred Contributions
- Rebalance Investments for Tax Efficiency
- Shift to Tax-Free Municipal Bonds
- Diversify with Tax-Efficient Index Funds
Personalize Retirement Strategy Adjustments
As a financial professional, my approach to adjusting a client's retirement strategy in response to tax law changes is systematic and personalized. Here's how I manage this critical aspect of financial planning:
Reviewing and Adjusting Strategies: Given the evolving nature of tax laws, I regularly review my clients' retirement strategies to ensure they align with current regulations and goals. Adjustments may be needed to reduce tax liabilities or seize new tax-saving opportunities.
Steps to Pivot a Client's Retirement Strategy
Review the Client’s Situation and Goals: I begin by assessing the client’s financial situation, including income sources, tax brackets, and retirement objectives. This understanding is key to crafting an effective strategy.
Analyze the Impact of Tax Law Changes: I examine how recent tax law changes affect the client's strategy, including shifts in tax rates, deductions, and income taxation. For example, changes to RMD rules might necessitate a different withdrawal approach to minimize taxes.
Evaluate Potential Adjustments: Based on the analysis, I explore adjustments such as reallocating investments to tax-advantaged accounts, modifying withdrawal timing, or considering Roth conversions to lock in lower tax rates and reduce future tax liabilities.
Implement the Revised Strategy: Once adjustments are identified, I work closely with the client to implement these changes. This might involve rebalancing their portfolio or adjusting their withdrawal plan. Clear communication ensures the client understands the benefits of these changes and how they align with their retirement goals.
Need for Professional Advice: Given the complexity and frequent changes in tax laws, it's crucial for clients to seek ongoing professional advice. Regular reviews and adjustments with a qualified financial advisor ensure that their retirement plan remains effective and compliant with current regulations.
This approach helps ensure that my clients' retirement strategies are optimized to meet their long-term financial goals while staying compliant with the latest tax laws.
Stay Informed and Model Outcomes
A shift in a client’s retirement strategy is a significant event, and from my experience, clients do not like major changes to their strategy, especially if the strategy is working. Nonetheless, a significant change in tax law, especially the most recent ones like the Inflation Reduction Act and the SECURE ACT 2.0, does stress the need for CPAs to encourage their clients to tax plan for such events. The most important aspect of shifting a retirement strategy, especially one impacted by a change in tax law, is to be informed. That means I subscribe to tax research applications that will send me breaking tax news notifications.
If I become aware of a change in the tax law, especially one that will impact even one of my clients, my next step is to review how my client’s current retirement strategy will be impacted by the change in tax law. This involves complex modeling outcomes through scenario planning. In the case a change in tax law will negatively impact my client, then I explore alternative retirement strategies to hedge against the negative impact. For instance, this may include converting an RMD (Required Minimum Distribution) to a QCD (Qualified Charitable Deduction), bunching itemized deductions, and even income-shifting methodologies, including retirement withdrawal strategies.
Once scenario planning is completed, I communicate my findings and plans of action to my client. Clearly explaining how a change in tax law will impact their retirement strategy ensures they are aware before the tax law change goes into effect and is a proactive approach rather than a reactive one.
For example, one of my clients recently opted in to comprehensive tax planning because they did not have a retirement strategy. Through comprehensive tax planning, I convinced my client to contribute the maximum amount to their 401(k), do a Backdoor Roth, and open a health savings account and contribute the maximum amount. My client followed the strategy perfectly.
In 2024, the SECURE Act 2.0 changed the way parents could save for their children’s education through a 529 plan; and that changed my client’s retirement strategy. That change allowed a 529 plan account holder to roll over up to $35,000 to a Roth IRA tax-free, beginning in 2024, if the account has been open for 15 years. And now my client, through a change in the tax law, has another investment vehicle to save for retirement.
Consider Who, What, Where, When, Why
There are a multitude of ways retirees and pre-retirees can adjust their retirement strategy due to tax law changes, considering the who, what, where, when, and why of retirement income.
Who and Where refer to the recipient of the income, whether it be an individual, trust, business, or charity, as changing tax rates could incentivize a retiree to modify the recipient. For example, one may have an added incentive to keep a business open for longer, taking advantage of associated tax deductions, should rates increase.
What refers to the type of income, and retirees may adjust their portfolios to prioritize capital gains over ordinary income, or tax-free income (such as the income generated by municipal bonds) over taxable income based on changes to the tax code.
When refers to the timing of receiving income, as increasing rates following the projected 2026 sunset may incentivize retirees to accelerate taxable income to 2024 or 2025 (including Roth conversions in some cases), reducing the burden at potentially higher rates in 2026 and beyond.
Finally, Why refers to the reason for receiving income at all, as higher tax rates may incentivize retirees to postpone lifestyle 'wants,' leaving more income in their retirement accounts and thus managing the associated taxes generated.
The examples above are just a small sampling of actions that retirees or pre-retirees could consider, and one should consult their financial or tax advisor to ensure all available strategies are considered and their planning is optimized.
Optimize Timing for Roth IRA Conversions
When tax laws become more favorable for Roth IRA conversions, it's a strategic move to convert traditional IRAs into Roth IRAs. This process allows pre-tax funds to grow tax-free, potentially offering tax savings in retirement when withdrawals are made. Since Roth IRA contributions are made with after-tax dollars, any shifts in tax rates may influence the best timing for these conversions.
By recognizing these changes in tax policy, one can efficiently manage their taxes in the long term. Look at your retirement plan and consider if now is the right time to make a Roth conversion.
Increase Tax-Deferred Contributions
Changes in tax legislation can significantly impact the effectiveness of saving strategies for retirement. As such, it is wise to increase contributions to tax-deferred accounts like 401(k)s and traditional IRAs when tax rates rise. Contributing more to these accounts can reduce your current taxable income, delaying tax payments until retirement when you might be in a lower tax bracket.
Timely adjustments in the contributions can result in considerable tax savings. Assess your current savings strategy and see if boosting your tax-deferred contributions makes sense financially.
Rebalance Investments for Tax Efficiency
Tax laws occasionally offer opportunities, such as reduced capital gains rates, that can influence how one should allocate their investment portfolio. By rebalancing investments, one might offload assets with large unrealized capital gains in a tax-efficient manner, taking advantage of the lower rates. It's about timing the market to optimize the tax burden while maintaining a balanced and diversified investment strategy.
Rebalancing takes careful consideration of current market conditions and future financial goals. Review your portfolio and consider if rebalancing to capitalize on lower capital gains rates is a step you should take.
Shift to Tax-Free Municipal Bonds
Investing in tax-free municipal bonds becomes especially appealing when new tax laws offer advantageous conditions. These bonds typically offer lower yields but the interest they pay is exempt from federal income taxes, and sometimes state and local taxes too, which can result in a higher after-tax return. Such investments can provide steady, tax-free income, which can be a valuable part of a retirement strategy, especially in periods of high taxation.
It is prudent to analyze these bonds' features and how they fit into one's overall retirement goals. Explore the possibility of shifting into tax-free municipal bonds to maximize your investment efficiency.
Diversify with Tax-Efficient Index Funds
Taking into consideration the nuances of the tax code, diversifying with tax-efficient index funds can provide a bedrock for a solid retirement strategy. Index funds often have lower turnover rates, resulting in fewer taxable events and therefore less tax liability annually. This efficiency can help in maintaining more of your investment growth and minimizing taxes over time.
With a variety of index funds available, it is important to select those that align with your retirement objectives while being tax-efficient. Review your investment options and consider augmenting your portfolio with tax-efficient index funds to bolster your retirement savings.