Advisers Score Points With Tax Talk

High-net-worth investors are worried their portfolios will be negatively affected by tax code changes.

According to a Nationwide Financial poll, 63% of high-net-worth investors are concerned that their portfolios will be impacted by tax code changes now that President Obama has been re-elected, and three in five (64%) do not believe it is possible to make adjustments to help offset pending tax increases.

At the end of 2012, Bush-era tax cuts expire, impacting the top four marginal brackets and eliminating the 10% bracket. The phase-out of itemized deductions for high-income earners is set to return, and tax on dividend income is set to increase from 15% to ordinary income rates as high as 39.6%, Eric Henderson, senior vice president of Life Insurance and Annuities for Nationwide Financial, told PLANADVISER. Long-term capital gains rates are scheduled to rise from 15% to 20% for most taxpayers. Those with high overall income and investment earnings will face an additional 3.8% Medicare investment earnings surtax. The gift and estate tax exemption is scheduled to shrink from $5.12 million to $1 million.

More than half (56%) of survey respondents think their individual federal taxes will increase. Nearly half (48%) expect tax rates to increase, particularly for the wealthy, and a third (30%) believe tax rates will increase across the board. In addition, nearly seven in 10 think Bush-era tax cuts will be completely eliminated (35%) or at least reduced (33%) for the wealthiest Americans.

Despite concerns, many investors may not enlist the help of an adviser. A recent Harris Interactive survey of 751 investors with $250,000 or more in annual household income or investable assets found six in 10 (60%) survey respondents say they either will not or are unsure if they will meet with a financial adviser to discuss how these changes may affect their portfolio.

“We don’t know exactly how lawmakers will draw the line between wealthy and middle-class investors, but when you consider the substantial budget challenge that must be addressed, it’s reasonable to expect that many of these changes will take place at least to some degree,” Henderson said. “Our newly re-elected president has already affirmed what he said on the campaign trail: He is going to look for new revenue to address the deficit by raising taxes on the wealthy.”

To position clients for changes that are still a bit unclear, advisers should help clients strive for tax diversification—meaning that a portfolio includes investments that are taxable now, taxable later and never taxable.

“There is a huge opportunity for advisers to proactively engage clients in a discussion about how tax code changes may impact their portfolio,” Henderson said. “Investors may miss an opportunity by waiting and, according to our survey, many of them are not planning to initiate this discussion.”

When helping clients, advisers should first consider the changes scheduled to take place at the end of this year. Henderson said advisers can also consider discussing the following with clients:  

  •  Harvesting gains to take advantage of current capital gains rates;
  •  Converting funds or investments that are currently taxable into tax-deferred vehicles;
  •  Paying special attention to dividend-paying stocks;
  •  Shifting income into 2012 to take advantage of lower rates;
  •  Funding a Roth 401(k) or Roth IRA;
  •  Converting traditional IRA assets to a Roth IRA;
  •  When 2013 arrives, consider maximizing deductible retirement plan contributions; and
  •  Shifting assets in taxable accounts to a deferred variable annuity.

Investors Find Meetings Helpful   

While only 10% of survey respondents have already met with their adviser, nearly all of those who did found it to be helpful in understanding tax code changes and planning changes to their portfolio that will minimize potential impact. Just more than half (55%) of respondents currently have a financial adviser, and most (82%) are at least somewhat comfortable talking to them about tax code changes and have confidence in their adviser’s ability to help them prepare for changes in the tax code (88%).

“It’s clear that clients who are having these conversations with advisers are glad they did,” Henderson said. “This type of proactive council can prevent clients from missing out on significant opportunities while building trust, cementing long-term relationships and opening up sales opportunities. While most financial advisers do not provide tax advice, our survey shows an opportunity for advisers to provide portfolio advice based on the implications of new taxes.”

Advisers can score “serious points” with their clients by making this effort, Henderson said, adding that it's likely to create sales opportunities. 

Henderson said Nationwide's survey indicates advisers shouldn't just wait for the phone to ring—they should invite their clients to talk about how the changing tax code will impact their portfolios. For clients who do not understand the urgency of this conversation, advisers should remind them that there may be opportunities to make significant adjustments before current tax law changes. If they wait until 2013, it may be too late to take advantage of 2012 tax rates, Henderson stressed.

“It's human nature to freeze at times of change and confusion,” he said. “Investors are overwhelmed and afraid to do the wrong thing. Many believe that there is nothing they can do, or don't know if it's possible to reposition their portfolios for increased taxes. It’s also possible that some investors were counting on a Mitt Romney victory, assuming that would lead to fewer tax implications.”

Nationwide's tax discussion guide is available to help advisers facilitate the conversation with clients. The document can be accessed here.

The Nationwide tax study was conducted online by Harris Interactive between September 28 and October 5, 2012. The survey respondents included 751 adults ages 18-plus who have $250,000 or more in annual household income or investable assets. The data represented here focuses on responses where respondents assumed President Obama would be re-elected.