Episode 1: 2021 Tax Plan vs. Tax Prep Part 1

Isaac Wright: Welcome to Wright Money Tips. It’s January 2021, been excited to relaunch kind of version 2.0 of Wright Money Tips. A lot is going to probably occur this year when it comes to various things and finance. But more importantly is we want you to live your best lifestyle possible. So we’ve been investing time, energy into the podcast.

Now, both audio and video. So, without further ado, I want to take a minute here, introduce our guest of the day, Ricky Lafon. Ricky is our senior advisor here at Financial Dynamics and Associates. That’s the financial planning firm that I own and operate here in Midlothian, Virginia.

Ricky’s a CFP professional. He also is a retirement income certified professional. And right before we got on to talk today, we talked a lot about the fact that right here in January, many of you are going to start receiving your 1099s, your W-2s. You are going to start compiling all of that information to be able to do taxes.

Well, we’re going to talk a little bit about taxes today on the podcast and some things that don’t feel as sometimes put in the right proper order when it comes to working with an advisor when it comes to taxes. So, with that in mind, I think Ricky, when it comes to taxes, tell me a little bit about how you feel getting out of the gate for 2021.

Ricky Lafon: Yeah, I think it’s a big unknown right now. You know, we’ve had a presidential election, we have no clarity on what’s going to happen with taxes now. But it’s our job as a fiduciary, to set and make some tax planning for this year and future years as well. The worst thing that we can do is to set back and say, we don’t know what’s going to happen and not have any plans whatsoever.

Isaac Wright: And let me say this too. And Ricky will definitely vouch for this. A lot of people, when it comes to taxes and getting all this information together, they say, “Well, you know, we don’t need any planning because we already work with the CPA or we work with an accountant.” What I want you to understand is this, that’s tax prep.

You’re taking all the information to the accountant for them to be able to plug that information. Then maybe you use TurboTax or other software. What we are talking about is what value can an advisor bring when it comes to planning for some taxes and how to be able to minimize those taxes. Over the past several years, there have been articles suggesting investment returns can increase 1% to as much as 3% annually.

If tax planning is considered when making decisions around your portfolio, you know the jury’s out on that to some degree. But I do believe, if you’re working with an advisor and you’re not discussing taxes, it’s a problem. And more importantly, is that you’re trying to accumulate and use your net worth for livelihood and lifestyle. That’s what we’re going to focus on today.

And we’re going to break this up into two parts. So part one today is going to cover what we call four tax planning tips. We’re going to cover the first two here. And, the first one I want to talk about for all of you today is what’s called asset location.

Ricky, if you had to define asset location; talk to me just a little bit about why that’s so important for somebody when it comes to taxes.

Ricky Lafon: Yeah, absolutely. I mean, you can have your funds in a traditional IRA, 401k. You could have it into a Roth account. You could have an annuity out there somewhere that may be an IRA.

It may be just a regular annuity that’s tax deferred, depending on how you have that set-up. And there’s also other rules to the game, which include how long the account has to sit there before you take withdrawals, required minimum distributions, etc. The number one problem I think that we run into is people not knowing which account to take from at what time.

Everyone’s going to need some withdrawals at some point. Whether it’s for a car purchase, home, purchase renovation, whatever the case may be. It’s our job not only to sit there and make your funds last, but to be tax wise with your dollars.

Isaac Wright: Well, so for example, you know, depending upon what type of investments you own, you may want to consider owning taxable bonds, real estate, investment trust, and even active managed funds in your portfolio through your tax qualified accounts, like IRAs, due to the ordinary income taxes that typically incur in those type of investments. Now on the other end of the fence, you may want to consider owning individual stocks you plan to hold longer than 12 months, passive index funds that are more buy and hold, and municipal bonds in a taxable account to take advantage of potentially lower capital gains tax rates.

We’re going to talk a lot more about that here over the next couple of episodes. But just know that asset location, if you’re not in a position where you understand this, you could actually push yourself into a higher tax bracket. You could actually put yourself in a place where you’re paying more in taxes related to not just your tax bracket. You could put yourself in a place where you’re paying higher taxes on your investments and even your social security. A couple of things there you want to talk about.

Ricky Lafon: Yeah, absolutely. That’s something that we have to look at because with that tax you’re going to have potentially, if you go over a certain threshold, another 3.8% tax on your investments that people just don’t think about.

Plus, we have to factor into social security. Now that’s a formula for combined income that we have to take into account, but we have some clients that may want to take up third quarter or fourth quarter distribution out, planning for Christmas or planned gifts or what have you. And, we have to be mindful of those things because that adds onto your income, which can cause more of your social security to be taxed. And then all of a sudden, we have a tax surprise by the time we roll around to Q1 of the current year.

Isaac Wright: Let me say this. We saw this happen twice at the end of last year with a couple of people that have come in to see us that had taken too much money out. And also, it kicked their Medicare Part B premium up pretty significantly.

So for those of you here, if you’re not 65 years old yet, just know when you turn 65, you go on Medicare. You may very well be in a position where if you’re not planning this correctly, in terms of the withdrawals that you’re taking and how it’s being taxed towards your overall income, it can definitely be a penalty, is what I will call it, on your overall taxes.

We do a lot of that planning here. Ricky and I both, our whole team here at Financial Dynamics, we’re really focusing at the year-end, we do a lot of year-end planning just to say, “Hey, listen, are there some small things that we can do to equivalate to a bigger result in terms of having more money net, let’s call it in your pocket if you will.

So, that’s the first issue is asset location, understanding the withdrawals, how it’s going to be taxed and also understanding what type of investments you want to hold and what type of account. So again, sometimes dependent upon if it’s taxes, capital gains, or ordinary income, that will definitely have an impact on where you want to hold that asset.

So let’s move on to the second topic as far as our taxes go. And this is actually probably in a way, a good topic is transitioning large amounts of gains. You know, we’ve had a great stock market here for over 10 years. I know we had a crazy month in March of 2020 and of course we’ve had a pretty nice rebound off of that.

And overall, the market’s been on a great run for some time. Well, that allows a lot of stocks that are held, to have significant amounts of gains. And a lot of times people get really frozen because when they get their statement, they know that the stock has done maybe so well that they’re going to have to pay a lot of tax if they sell that stock.

And sometimes that can really be harmful. And Ricky, why don’t we talk a little bit about that here, about how we handle that here at Financial Dynamics. Because sometimes what happens, quite frankly, is that we don’t want to see the tax tail wag the dog.

Ricky Lafon: That’s exactly right. And you know, when we see something like this and it may be an inheritance, a person has, or maybe they have invested in a drip system over several years and they’ve got an accumulated value. Our job is to basically bring those assets in house, to evaluate those. There’s no knee jerk reaction that we’re going to make to any of those positions. We always want to, as a fiduciary, put our clients in the best position possible. That may mean selling off some of those assets over time to diversify those, that may mean holding onto some of those for a dividend reinvestment.

There’s several different options that we can take there, but we have to be mindful of current long-term capital gains taxes.

Isaac Wright: Yeah, and if it doesn’t change now, it’s likely going to change in the future. We don’t know exactly what the future holds, but I think the reality of the amount of programs and stimulus that’s been out there, the wise dollar says we’re going to pay more in taxes, what I would say.

But also keep in mind, and I think this is good to kind of parlay off of what Ricky said. When it comes to having stock that has had significant appreciation, you may be able to. We’re going to talk about this in our next episode, you may be able to offset some of that with losses from other stocks.

Again, we’re talking about taxable accounts, by the way. This is not IRA money, IRA money, really you can do almost anything you want to in that portfolio and not trigger attacks until you actually take the money out. But this is taxable accounts, money that you have outside of your qualified assets and this is a big deal.

A lot of people like what you said about drips, a lot of people have drips with different stocks they’ve had for many, many years. And all of a sudden, they just don’t know what to do because they don’t want to pay the tax. And I think the problem is, they can take that money, maybe split that tax out over several years, have a tax strategy. And then from there, be able to diversify into other stocks that maybe pays them equal dividends or something that gives them a little bit more diversification. But we’ve seen a lot of people hold on to very highly concentrated positions in stocks. As a quick note, we talked about this before and got kind of the devil’s advocate approach here.

If you have a stock and you know you don’t need it for lifestyle support. And even though it may be highly concentrated or it’s a ton of money in one stock, we have to be careful about not losing the step-up in basis. If this is money, that’s ultimately going to go out to kids.

Ricky Lafon: You know, that’s a great point there. I think that comes with us getting to know our clients and what their true wishes are. If this is something that they truly want to pass along to kids, grandkids, and of the such, that’s a great point that you just made and we may want to hold onto those for that step-up in cost basis. So that the ultimate beneficiary of those will have less taxes.

But one thing that we need to talk about as well, we’ve got many, many clients, and I worked with several in 2020 for charitable contributions. So if you have a highly appreciated asset and you are giving to a college, a university, you’re tithing to your church; we can actually transfer those assets over in place of what you’re already doing and that’s a very tax efficient way of moving those assets and blessing that college, university, church, etc.

Isaac Wright: Very good. Well, listen, I hope everybody’s enjoyed the little introductory version of our Wright Money Tips Version 2.0 Podcast. I’m Isaac Wright, Ricky Lafon.

We have a election report that you can download that’s going to talk a little bit about where taxes may be going in terms of the political landscape we’re in today. I hope you find that to be helpful.

Again, you can spell Wright Money Tips with a W. And we’ve even made it easy to where you can throw the R in there and not even put my first initial of my last name on there. So, anyway guys, listen, I want to say thank you for tuning in and we’ll talk soon.

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