Victor Colella:Hi everyone. My name’s Victor Colella, and I’m a financial planner with our planning team here at Adviser Investments. Today, I’m joined by my colleague Rick Winters. Rick is a vice president at Adviser. You’ve heard him on another podcast before; I think. He works with individuals and institutions to help them reach their financial goals, so he’s a relationship manager here. He’s a certified financial planner, and he has earned other designations like the CRPC®, Accredited Wealth Management Advisor (AWMA®), you name the alphabet soup, he may have it.
Rick Winters: Keeping busy over here…
Victor Colella: That’s a fancy way to say that he likes to learn. So now that I’ve inflated his ego, let’s introduce the topic. Today we’re going to talk about the seven habits of highly effective investors. This is seven steps that you can take now to reduce your tax bill. For me, one of my favorite books is The 7 Habits of Highly Effective People. Whenever I hear there’s a list of seven actionable steps I tend to pay attention, so hopefully it has the same effect. I’m not going to waste any time. I’m going to jump right in.
Our first habit is to rebalance continuously, not systematically. What do I mean by that?
Rick Winters: Yeah, so let’s break that down a little bit. Think about it: You’ve been spending all this time putting together a strategy, working with your adviser, thinking about it independently and you hit this target allocation. For example, “I’m going to be 60% stocks and 40% bonds and cash.” Then, a year later, the market’s done great, and now you’re sitting on 65% stocks and 35% bonds and cash. What do I do?
Rick Winters: Well, conventional wisdom would say in January, get back to that portfolio and rebalance it. But here at Adviser Investments we would not take that path. It’s a much wider view of how to handle that rebalancing process. So that habit would be to use your portfolio and the things that are going on it like distributions, the need for cashflow that could come at any time throughout the year, and use those opportunities to maybe rebalance that allocation a little bit. So when that cash pops out of a fund at one point, you can use that to turn around and maybe replenish some of your bond positions.
Victor Colella: It may be in January, but just because it’s, say, January doesn’t mean it’s the only month of the year that should rebalance.
Rick Winters: Yeah, because if you’re sitting there and you sell in January just as a rule, well you’re going to be doing something that really is not advantageous. You’re going to be realizing capital gains a lot of the time and that comes to the cost of tax. If I know I’m going to have things going on in my portfolio that are probably going to be distributions and other things that are going on that are going to create tax situations, maybe I should use those to my advantage.
Victor Colella: Yes, you should be taking those distributions maybe from those parts of the portfolio that have done really well, and vice versa when it comes to when you get money that’s coming into the account. Maybe you put it into the funds that have lagged.
Rick Winters: Definitely.
Victor Colella: Great. So said another way, let life dictate your rebalance strategy, not the other way around.
Rick Winters: Yes, that’s a good habit.
Victor Colella: Speaking of calendars, that’s the second habit. This one relates to mutual fund distributions, so know your fund distributions and build a calendar if you can. Rick, talk about fund distributions and why we build a calendar here.
Rick Winters: A lot of people think of this—especially if you’re a mutual fund investor, you’re not new to distributions. November and December are when you would normally see some of the larger distributions. But the habit is to start in January. Think about it, when I get to January I don’t buy a whole slew of new mutual funds. I wind up owning the same ones I owned the year prior. Mutual funds have a strong history of following the same distribution schedule, year after year roughly around the same date.
Rick Winters: If I know that in advance, I should build my calendar, something we use here as a gatekeeper, so we don’t wind up buying distributions at the wrong time or maybe I’m aware of a cashflow that’s going to come from a fund so I can use it. I mean, I have to buy something: Groceries, a car, give a gift. I can work my way through the year knowing when those distributions are going to happen.
Victor Colella: Yeah, and we specifically create a calendar. We’re always keeping an eye on it, but we create a calendar in October because a lot of our funds happen to distribute towards the end of the year. You would hate to buy a fund distribution and unnecessarily incur capital gains that you haven’t been there for, right?
Rick Winters: That happens all the time. Cash is showing up at all different times throughout the year. If cash shows up in September, everybody says, “Well I don’t want to buy those distributions.” Well, you may not want to, but maybe there’s other strategies you can employ. But blindly putting cash into a fund that’s about to pay a distribution for gains that you did not get…? That’s a bad habit.
Victor Colella: Got it. So speaking of gains and losses, that takes us to our third habit. For all you Stephen Covey nerds out there, this one’s for you. Be proactive when it comes to tax-loss harvesting. We talked a little bit about gains and losses, but what are we talking about here, Rick, with tax-loss harvesting?
Rick Winters: I’ll state it clearly up front: Tax losses have economic value, and if you’re not paying attention to your portfolio, you are missing out on an opportunity to put money back in your pocket. I’ll give a clear example.
Victor Colella: What’s a tax loss?
Rick Winters: So here tax loss is… Well, tax gain. Maybe I’ll start with that first, and then we’ll work our way back to why I want to realize that loss. Let’s say I make a good investment. I have $100,000, and I invest it and it grows to $110,000. Now, I want to move that position somewhere else, and I sell it. I realized a $10,000 gain. That’s great, but there’s something that comes out of that. That’s a capital gain, and I may have to turn around and pay taxes on that—anywhere from zero to 30%, whether it’s long-term or short-term, and depending upon what state you live in.
Rick Winters: If I turn around from there and I say, “All right, I’ve got this $10,000 gain,” and I made another investment. Now I have $100,000 in another position, and that position drops to $90,000. I just let it sit there, saying “Oh, I hope that comes back.” What I actually should do is consider selling that, realize that loss and use that $10,000 loss to offset the gain. Now I don’t have to cover that tax. An important part here is that you don’t want to just let that position I just sold at a loss sit in cash, so maybe I’ll turn around and buy something similar. Use it as an opportunity to rebalance my portfolio, or use it to buy another position I’ve been looking at.
Victor Colella: Sure, so if it was a large-cap stock in utilities or a large-cap mutual fund, you can buy another also similar quality mutual fund with large-cap stocks or…
Rick Winters: Because, you can’t buy the position right back.
Victor Colella: Yeah.
Rick Winters: Because you’re going to be facing a wash sale, which is a downfall to not knowing the rules around tax-loss harvesting.
Victor Colella: One thing to know here as well is that you can carry losses forward. So if you do take a loss in a given year…
Rick Winters: Definitely.
Victor Colella: And because of the way that your gains and losses have shaken out, maybe you don’t use the full loss this year. That doesn’t mean it goes away. You can carry that forward to the next year.
Rick Winters: That’s right and if I’m possibly net negative, I can even use some of that against normal income. It’s limited, but I can use some of it and then carry it forward indefinitely.
Victor Colella: Yeah, a few thousand dollars a year. Great. All right, I think we’ve covered that one. Just to keep us moving, the fourth habit is stay away from automatic reinvestment in your taxable accounts. The taxable account part of this one is pretty significant. Could you go a little deeper on that.
Rick Winters: Just to put IRAs on the side, if I have a distribution coming in my IRA it’s not a big deal. I just have it reinvested, because I don’t have to worry about. I can rebalance at any time, assuming you operate like we do where there’s no transaction expenses on making a trade.
Victor Colella: Which may or may not be the case.
Rick Winters: It may or may not be the case for others, but for us it’s a cost-free transaction. We can rebalance at any time. But in my taxable accounts, that’s not the case. In there, if I have things reinvesting and I need a cashflow, my only alternative because I didn’t let that distribution fall to my money market, is to sell something. Then I’m going to incur an additional capital gain, most likely that I’ll have to pay taxes on. With your distributions, the habit is to have all taxable accounts pay to the money market, so I can choose what happens with that cash. I can rebalance. I can buy my groceries. I can get that gift that I should be always thinking about for my loved ones.
Victor Colella: That makes sense. And one other thing, these first four habits really do work together because we talked about fund distributions. If you’re automatically reinvesting, you may unintentionally buy a fund distribution. Of course, it’s less of a big deal within your IRAs and other tax-sheltered accounts because there’s no gain or loss cost to sell.
Rick Winters: That’s right. Be aware: You’re putting the control back in your hands by not force-feeding your taxable positions with additional cash.
Victor Colella: These are all really just about being a little bit more informed about taking money from and adding money to your portfolio. That’s how these first four all work together.
Rick Winters: Definitely a good habit.
Victor Colella: All right, so number five. The fifth habit is to take full advantage of tax-deferred and tax-free growth. This one might seem obvious to those of you who have been IRA, Roth IRA and 401(k) contributors from the beginning, but it’s sort of a moving target. Could you talk a little bit about this?
Rick Winters: This habit is because over the last 15 to 20 years, this has been a moving target. Every year there’s a chance that because of inflation, that these contribution amounts have increased. If you were just meeting the limit last year and now it’s increased and you don’t make an adjustment, or at least revisit what you’re potential income is for the year, you’ll be missing out.
Rick Winters: So what’s the habit? The habit is to max out those contributions, and the way you’re going to do that is to start in January and readjust your contribution rate to make sure you’re going to hit it. Maybe you turn 50 and you’ve got a catch-up provision that gives you an extra $6,000 you can put into your 401(k). These are things that you have to think about in advance, so that it’s not last paycheck of the year and I’m trying to get 100% of my check in there.
Victor Colella: So, Rick, I do want to jump in. If you forget to do this in January and reset your contributions, or maybe you decide not to intentionally, there are different deadlines for different types of accounts. You have until December 31, the end of the calendar year, to make sure that you get all of your contributions in for your 401(k)s, your employer-sponsored accounts…
Rick Winters: 403(b)s…
Victor Colella: Yes.
Rick Winters: 457 plans…
Victor Colella: But for IRAs, Roth IRAs, some other self-employed retirement accounts and even HSAs—which is a personal favorite of mine if you’ve listened to the HSA podcast, they have until April 15th (your tax filing deadline), before you have to get that full contribution in.
Rick Winters: Definitely. Even for some of those self-employed plans. If you’re self-employed, you actually have until potentially even October 15th to get those contributions in. Be aware. Don’t miss it. Plan ahead.
Victor Colella:All right, and we do have a Key Financial & Tax Planning Data sheet that we release each year that has both the deadlines.
Rick Winters: I’m glad you mentioned that because that’s, as I define it, the world’s greatest cheat sheet.
Victor Colella: Exactly.
Rick Winters: We’ll have that out there so you can, not cheat your way through the year, but take advantage of that knowledge up front.
Victor Colella: Exactly. So our sixth habit is to never ever, ever, ever miss a required minimum distribution from your accounts. We spend a lot of blood, sweat and tears to make sure this doesn’t happen to our own clients. But what should you be looking for here?
Rick Winters: Yes. It is blood, sweat and tears for the last three months of the year where we’re running through that pile of spreadsheets, making sure everybody’s got their distribution and here’s why. Again, that habit is never miss the distribution because there’s a 50% penalty on that required distribution, which is more than any tax you’d pay on that distribution.
Rick Winters: With required minimum distributions, the caveat, well, there’s two actually: One is if it’s the first year you’re taking your RMD, the year you turn 70-1/2, you can actually delay that distribution until April first, but that is the only exception within the IRA space. For the 401(k)s, if you are still an active employee under your 401(k), 403(b) and contributing, and you are over 70-1/2, you can actually delay that until the year you fully retire.
Victor Colella: Just to back up for a moment. Here’s what required minimum distributions are. The IRS says, “We’ll give you this tax-deferred growth vehicle, but we’re not going to postpone our income taxes forever.”
Rick Winters: Yeah, they’re not going to give you that break forever.
Victor Colella: At some point you have to pay the piper, in this case, Uncle Sam.
Rick Winters: All that tax deferral.
Victor Colella: They draw that line at 70-1/2. I don’t know why it’s not 70. I don’t know why it’s not 71. It’s 70-1/2. Most of our clients take it in that first year and then they take their second one the following year. But there is that provision that you talked about.
Rick Winters: The delay until April 1 would require that you take two in that year, so that’s not necessarily a good habit.
Victor Colella: If you miss $50,000 of required minimum distributions, you just flushed $25,000 down the proverbial toilet, which I don’t think any of us would do willingly.
Rick Winters: No.
Victor Colella: All right, so last but definitely not least , we really like to talk about this one. I know that Rick, in particular, has made this the center of his clients’ focus. The habit is to always give with taxes in mind. We know you give with your heart, but there are a lot tax benefits on the table if you just know what to pay attention to.
Rick Winters: Think about that: Most people, when you think of giving, it’s a little bit of a rush at the end of the year. Obviously you’re giving throughout the year. Maybe it’s to a church or a specific organization or a cause that you feel strongly about. That really, to get down to it, is the most important reason for giving to charity. The secondary benefit is that you’ve been able to save on taxes. However, under the new tax law that was put in place last December, a lot of things changed. So normally if you’re itemizing your deductions and taking a bigger deduction because you’re able to itemize, then every dollar you give to charity’s going to be deductible.
Victor Colella: That’s most people who have a mortgage, for example, because historically that would usually put you into the itemization. We don’t want to go too deep on taxes here.
Rick Winters: Definitely, but what’s happening now is that , well, two-thirds less people under this new tax law are going to be able to itemize. So people who would normally just write a check and know it was going to come off on the tax return, that may actually not happen now. What you’re trying to do is make sure that your charitable giving is fully effective and you are able to take full advantage of the tax benefits.
Rick Winters: A couple of strategies that people are employing now are to group gifts, so group them together. If I normally give $5,000 in a year, maybe now I’m going to give $15,000 because then I’ll be able to deduct it. I know that’s a big number, but this is what we’re actually going to have to talk about to get to this threshold, which is exceeding the standard deduction and that’s $24,000 for a couple filing jointly. Getting over that number does require a lot of capital to get there.
Victor Colella: A lot of our clients, when we talk about the lumping or grouping strategy, they’ll say, “Well, if I give five a year, I don’t want to give $15,000 this year. That makes it hard for my charity to plan.” A lot of our clients will use what’s called a charitable gift fund, which you can even gift cash.
Rick Winters: Definitely, yes.
Victor Colella: If you really want to turbo-charge your tax benefits, you can gift some of that low-basis stock that my grandpa gave me as a birthday present when I was 10. You can gift that stock, avoid paying the capital gain and then still get the deduction in the year that you do the gifting while you can then gift that to the charity over time.
Rick Winters: That accomplishes something else. I think charity is not just something I do: I don’t just pop out my checkbook and write it. You want to think about this. If you’re running a business, you can’t just walk in and be like, “I think we’ll do this today.” Write a mission statement. Write a vision statement, so you know what you’re trying to do.
Rick Winters: And using those donor-advised funds allows you to make sizeable contributions without writing the check directly to a charity. It can actually stay invested as well, and this just gives you an opportunity to build a little bit more of legacy and helps you accomplish the second big goal: Teach other people in your family, kids ideally, how this charitable giving and philanthropy can be so important. There is another way that’s actually very important, because it plays on number six, which is required minimum distributions.
Victor Colella: This is a big one.
Rick Winters: We’ve been spending a tremendous amount of time on the QCD, qualified charitable distribution. This is basically saying that when you are of required distribution age, so over 70-1/2, and you’re taking your required minimum distribution, you can give that distribution directly to charity.
Rick Winters: The cool thing about that, unlike what we were dealing with before trying to get over the standard deduction so I could save taxes, this one actually removes that income from your tax return all together. It’s non-reportable, non-deductible. The fact that I’m not even reporting income lowers my income threshold for things like medical deductions or even the calculation on my Medicare premium. We’ve been spending a ton of time on making sure every client knows about that advantage.
Victor Colella: And you can’t do that until you’re 70-1/2, so that’s one that… I’m just not sure who celebrates their 70-1/2 birthday
Rick Winters: The charities!
Victor Colella: On that day you should start reevaluating a couple things. That’s what I’m talking about.
Rick Winters: You can’t give that QCD directly to those donor-advised funds, but you definitely can give it directly to charity. I want to make sure that that’s clear.
Victor Colella: There’s a lot of complication when it comes to charitable giving, and it’s a moving target. We got new rules recently, but there’s lots of opportunity contained within. I think we’ve covered that one.
Victor Colella: I’m going to do a quick recap of all of our seven habits, and then we can conclude. First habit was rebalance continuously not systematically. Our second habit was know your fund distributions and build a calendar. The third habit was be proactive when it comes to tax-loss harvesting. Don’t just wait until the end of the year. Number four was stay away from automatic reinvestment, specifically in your taxable accounts. Number five was make sure you’re taking full advantage of tax-deferred and tax-free growth. Number six is, never ever, ever, ever miss a required minimum distribution. The penalty is just too high. Then last but not least is always give with your heart but also with taxes in mind.
Victor Colella: You’ll notice a lot of this is tax-related. It’s a great time all year around. I mean, tax season is always right around the corner, especially at the beginning of the year and also at the end of the prior year. But you should always be thinking about it. Huddle with your investment adviser and your CPA and make sure you’re taking advantage of all the opportunities that are out there.
Victor Colella:This has been Victor Colella and Rick Winters from Adviser Investments, and we thank you for listening to The Adviser You Can Talk To Podcast. If you’ve enjoyed this conversation, please subscribe and review our show. We really do like your feedback. You can also check us out at www.adviserinvestments.com/podcasts. Your feedback truly is always welcome, so if you have any questions or topics you’d like for us to explore, please email us at firstname.lastname@example.org. We’ve already done a couple client-suggested podcasts and we enjoy them more than anything because it’s better if it’s what you want to hear.
Rick Winters: Keep the questions coming, please.
Victor Colella: Thanks again.