Now Is The Time To Discuss Tax Diversification With Your Clients

By Eric Henderson

With the first couple months of the year under our belt, the future of federal tax policy remains murky as ever. Build Back Better continues to be in limbo, and we’ll need to wait to see how mid-term and subsequent elections impact the federal tax landscape.

It’s not surprising that investors list taxes as one of their top three biggest financial concerns – a number that nearly doubled since last year according to Nationwide’s seventh annual Advisor Authority study, powered by the Nationwide Retirement Institute. Taxes are also one of the top macro factors advisors and financial professionals say will adversely impact their clients’ portfolios, along with the COVID-19 pandemic and inflation.

With these factors contributing to ongoing uncertainty, it’s important that you’re working with clients now to help them feel confident in their plan for the future. This is a great opportunity to help them understand how tax diversification can lead to more confidence in an uncertain tax environment, both now and in retirement.

It’s clear that taxes are a blind spot for many investors. In fact, 42% of retirees did not consider how tax rates would affect their retirement income when planning for retirement, according to Nationwide’s 2021 Tax-Efficient Retirement Income survey. As a result, they could face significant, avoidable tax consequences in retirement. That’s why it’s so important for advisors and financial professionals to have conversations about this important topic before it’s too late.

There is no crystal ball: the case for tax diversification

Start your conversation by introducing the concept of tax diversification, helping your clients understand how a mix of different taxable, tax-deferred and tax-free vehicles can provide flexibility and control that can help determine not only how much they pay in taxes, but also when taxes are paid.

It may seem like a simple question for your clients: Do I want this to be taxed now or later? Another way you can help them think about it is – are they better off paying taxes in their current tax bracket or will it be better to do so in the tax bracket they find themselves in when they retire?

For clients who think they will be in a higher tax bracket in retirement, tax-free accounts such as Roth IRAs appear to make a lot of sense. For those who could potentially slip to a lower bracket, tax deferred accounts like 401(k)s or traditional IRAs may be advantageous. For clients who expect to remain in the same tax bracket in retirement, Roth and traditional IRAs have similar benefits.

Your next step should be helping them see the answer to this question is not straightforward. Unfortunately, no one has a crystal ball. In fact, the only thing we know for sure is that it’s impossible to know exactly what tax brackets will look like in 10, 20 or 30 years. That’s why they will likely need a mix of taxable, tax-free and tax-deferred elements in a diversified portfolio.

When clients understand this concept, you can pivot the conversation to where there may be gaps in their current portfolio. This may include tapping into logical retirement account solutions, like further leveraging their 401(k) plan, turning to traditional IRAs, Roth IRAs or even Roth options within their 401(k) account. Additionally, clients may want to leverage taxable accounts, such as a brokerage account, that allow for more flexibility if they need to withdraw money early in retirement.

After maxing out these options, there may be solutions like annuities that could fill a gap. For example, clients could consider investment only variable annuities as they allow nearly unlimited contributions. In addition to helping with taxes, annuities may be a good tool to address client concerns about inflation (allowing them to participate in market gains) and market volatility (providing a measure of downside protection) at the same time.

Whether you’re helping a client build their strategy from scratch or fine tuning a plan, these conversations will strengthen your relationship with your clients and help them feel confident that they have made strategic decisions that help position them for the future.

Eric Henderson is president, Nationwide Annuity. He may be contacted at [email protected].