Now that the tax season is over, this is perhaps the slowest time on the calendar for many financial advisers. Some big
financial planning and tax-related decisions have just been made, and while other important ones loom, many clients prefer to put those off until later in the year.
Before too much time passes, though, it's important to schedule follow-up sessions. It's a good way to not only do a quick post-mortem of a client's recently concluded filings, but also to lay the groundwork for the rest of 2017 and beyond.
(More: Changing state residency: Tax planning headaches and opportunities)
Recently, one of the things we have discovered in these types of meetings is that some of our clients have become far too preoccupied with scoring large tax deductions — even when it's to the detriment of their long-term financial plan and could lead to a liquidity crisis further down the road.
In particular, it's common to confront small business owners who take this approach to taxes, which is understandable given all the ways in which they are sometimes able to leverage the tax code to their advantage.
For instance, as many advisers know, small business owners can defer a significant portion of their income each year by sponsoring a retirement plan for their employees. The exact amount and whether this approach makes sense depends on a few variables, including the business owner's age, the plan type, the demographic makeup of the staff and the number of plan participants.
But if everything aligns, it's potentially a valuable benefit that could significantly minimize their individual tax burden over time. Problems, however, can emerge when the business owner begins to approach retirement. At that point, a couple of things could be happening simultaneously.
First, even as it's possible that they have amassed considerable assets using pre-tax vehicles, ideally it'd be best to leave those untouched until they are obligated to take a
required minimum distribution at age 70.5, when their marginal tax rate will likely be much lower. At the same time, their income and after-tax savings could be slightly waning as they take a small step back from managing the day-to-day operations of their business.
(More: The conundrum of state-run retirement plans)
It's easy to see how this scenario could set up a serious liquidity crunch for someone, say, in their mid-60s who may still have a series of obligations to take care of (mortgage, child's college tuition, etc.) but who, due to tax and financial planning considerations, shouldn't tap their qualified investments. But many small business clients don't think about it this way. All they know is that they want the same big deduction they've always gotten in the past, thanks to their sponsorship of a company retirement plan.
In cases like this, an adviser has a responsibility to intervene, to reign in this natural impulse and make the client understand the bigger picture.
Other similar examples of the tail wagging the dog include making huge, though somewhat questionable, capital investments in hopes of writing off those costs. We've seen this with medical practices that purchase expensive diagnostic imaging equipment. Sure, that's nice to have, but it's not a must have, since third-party labs provide patient access to such equipment when it's necessary.
In a vacuum, these moves make sense. But when these deductions — as well as many others like them — are not weighed against a broader financial plan, they can end up causing considerable problems.
(More: How to serve clients during a Trump presidency)
None of this is intended to question the importance of tax planners. On the contrary, it only seeks to highlight the importance of taking a holistic and team-based approach to service, with CPAs, estate attorneys, advisers and others working together to achieve the best outcomes for clients. In this era, when asset management and other once-important financial planning tasks are quickly becoming commoditized by emerging technology platforms, it's imperative to stay competitive by providing as much value as possible in other areas.
Jonathan Albano is a partner at CCR Wealth Management, an independent financial planning and investment management firm.
