How a CFP Optimizes the 3 Types of Retirement Accounts for Taxes

In light of similar changes already in effect, the CFP, who manages $100 million in client assets, recommends that advisors consider strategies for reducing tax consequences through tax-loss harvesting (to balance the rebalancing that occurred last March when many investments sold at a loss); more gifting by $1 million-a-year earners; and managing expected higher taxes when selling a business.

Diversifying holdings based on tax liability uses the familiar three-bucket approach, but from a tax perspective: tax-deferred, taxable, and tax-advantaged. That last bucket will be key this year, says Oschman, who recommends Roth IRAs to maximize retirement income.

The 10-year advisor, 32, started out as a hybrid firm FA, then three years ago co-founded Nashville-based Vestia, whose niche is helping physicians manage their finances and offering tax planning as related to their investments.

ThinkAdvisor recently held a phone interview with Oschman, speaking from her Nashville home. The firm’s chief marketing officer as well as chief experience officer, she says a three-bucket approach to tax planning “allows you to withdraw the most value based on your tax rate environment when you’re retired.”

Here are highlights of our interview:

THINKADVISOR: Over the last year, legislation has continually changed — and much of it has impacted taxes. There’s the Paycheck Protection Program, new tax guidance in the American Rescue Plan, the stimulus check payments — all happening virtually at once. What are you zeroing in on sharply to help your clients, who are all high net worth?

LAUREN OSCHMAN: Higher earners were largely phased out of the American Rescue Plan. That means I’m focusing on impending legislation that’s probably going to increase taxes to raise money to fund that plan. It’s wise to pay close attention to development of all these legislative proposals.

How are you keeping on track and on top of all the proposals with specific regard to your clientele?

I have a heat map [graphical matrix] of 65-75 of my clients to see who will be the most heavily impacted by the big changes that could come from this legislation.

What action would you then take?

As we see things [emerge] that are very likely to be part of it, I want to make sure we’re moving quickly [to help]. People who make over $1 million a year are going to be impacted a lot more by certain changes than those making $250,000. The heat map lets us know who we need to act most quickly with, depending on what becomes reality [law].

What’s one potential change that you consider crucial to address?

You should be reviewing clients’ net worth because one of the biggest changes is that the estate and gift tax exclusion could go down significantly. So clients that have higher net worth or that do a lot of annual gifting should consider strategies to use that high exclusion now before anything changes.

What tax could go up markedly?

If you were to sell your business, the amount would be taxed at a rate that could be significantly higher. Therefore, we’re going back to [look at] the financial plan for clients who are depending on revenue from the sale of their medical practices to fund a lot of retirement goals. We’re having conversations about how this legislation could impact that and change their trajectory or what changes we need to make to keep them on track to course-correct.

How can investors make the most of three types of retirement accounts?

People always talk about diversifying from an asset class perspective. I always talk with investors about making sure they’re diversified from a tax perspective. It’s just as important.

How do they do that?

Advisors should be mindful of diversifying clients’ investments across three different buckets of money so that there are various income streams to pull from to create a retirement paycheck that generates the least tax liability. It’s after-tax growth that funds investors’ goals.

Do clients readily “get” this?

I’ve talked with a lot of potential clients who have three different pots of money, but they’re invested very similarly. So they’re giving up a little bit. You need to think about the characteristics of what you’re purchasing and about the tax bucket that’s most favorable to hold that investment. That way, you help to maximize the after-tax return, which is really what it’s all about.

What are the three different buckets?

Tax-deferred — such as a 401(k) account, where you pay tax when you take the money out; taxable — you’ll pay tax on your capital gains, which historically has been lower than income tax rates; and tax-advantaged, or tax-free, if withdrawn in retirement — assuming we don’t see legislative changes on these between now and then.

What are the biggest benefits to tax-advantaged accounts?

You can keep highly appreciable assets, for example, in a tax-free account — which means you’re sheltering them from the government. If you put dividend-producing investments — which come with ordinary income tax — in tax-deferred accounts, it protects investors quite a bit as their portfolios grow. The tax-advantaged bucket is going to be key because one of the [main] elements of the proposal for high earners is that they cap [itemized] deductions at 28%, regardless of their income tax bracket. So using Roth IRAs really maximizes that future income stream. Roth conversions would be a strategy worth considering.

Is gifting a good way to soften the tax blow this year?

Particularly for those making over $1 million of income, there’s a proposal to tax capital gains at income tax rate rather than at the more favorable capital gains tax rate. So if you have clients making that level income who are charitably inclined, there are a lot of strategies that you can explore to gift away some gains in 2021 at a higher deductible value.

Any other important strategies to use?

One of the notable things about investing last year is that even though a lot of portfolios ended 2020 with a gain, if rebalancing was done — because there was so much volatility in the spring — a lot of investments were sold, essentially, at a loss. So this would be a year for tax-loss harvesting to balance out some gains. That opportunity exists every year, but 2020 wasn’t the norm in that we had such a strong year in the market but really good opportunities for tax-loss harvesting in the middle of the year.

Taxpayers may be confused about the IRS’s “selective” extension to file 2020 income tax returns. What are your thoughts?

The IRS website says that the filing deadline for 2020 federal taxes is May 17, but the first estimated payment for 2021 is still due on April 15 — so we need to [proceed] as if it is. But for clients who are impacted by any of the COVID-19-related legislation, it’s probably wise to hold off filing those 2020 returns until we’re sure we have all the IRS guidance associated with that legislation. [Many] 2020 state returns likely will be due on April 15 [other states will provide an extension].

Your client niche is female physicians. What do they, in particular, need to know about tax planning?

It’s especially important to focus on the after-tax value of their investments because [firstly,] women don’t get paid the same amount as men [for the same work]. So with females earning less to start with, tax planning becomes even more important.

One key element pertains to female physicians who have working spouses. Paying attention to what they elect for tax withholding on the W4 form from the IRS is really important because when you’re working with two different payroll systems from two different employers, neither [would be aware] that that household [is] in a higher marginal tax rate bracket. If you don’t have additional withholding [taken out] on at least one, if not both, of those payments, it can lead to a really large amount owed on tax day. I spend a lot of time working with clients and their accountants to make sure they don’t have that unpleasant April [or May].