A friend of mine has been considering moving from California to Nevada’s Lake Tahoe region. He mentioned all sorts of reasons in a recent conversation: slower-paced lifestyle, fresh air and outdoor sports, far less traffic, and better overall quality of life. I responded, “You might have left out the biggest reason of all,” so he asked me what I meant.

As a business owner, my friend was about to give himself a big pay-raise that he had overlooked. I asked him a few more questions and then did the math in my head. I estimated that the impact to his lifetime net worth might well be over a million dollars. This difference would come from reduced living costs in a less expensive area and—most importantly—lower taxes.

The California state income tax rate is one of the highest in the nation—right now the top marginal rate is over 13%—while Nevada has no state income tax at all!  By eliminating state income tax, he would effectively realize substantially more net income.  If he invested that income effectively and let it grow over time, it could have a very significant impact on his net worth.

What does all of this tax talk have to do with investments?  Isn’t wealth building all about getting the best investment returns possible?  I don’t think so.  Unfortunately, you can get better-than-market-average rates of return on your investments only to have your gains wiped out by just a few poor tax decisions. I’ve seen it happen, too many times.

As a financial advisor with a Master of Science Degree in Taxation, I have come to realize that investment and tax advice must go hand-in-hand. If you get investment advice from one source and tax advice from another—and these two sources do not closely collaborate—you are very likely to miss substantial opportunities to grow your net worth.  Here are 4 reasons that wealth advice must be paired with tax-mitigation strategies.

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"I take great pleasure in helping my clients find better and more tax efficient ways to pass their wealth on to the ones they love and the charities about which they are passionate."

A Tax Bill I Could Not Prevent

A couple of years ago I started working with a new client couple. I reviewed their overall financial situation, including their tax returns, and asked about a $20,000 tax bill that jumped out at me right away.  After looking carefully at their situation, it became clear to me that we could have greatly reduced or eliminated that $20,000 tax bill by taking certain steps — which were no longer available.

There’s nothing worse than telling someone, “If we had looked at this 6 months ago, I could have saved you $20,000.” But unfortunately, this sort of thing happens far more often than you might realize. After reflecting on this and many similar situations that I’ve encountered over the years, I wanted to share the top 4 reasons your wealth advisor needs a tax orientation:

  1. Taxes have a direct impact on your bottom line.
  2. Government regulations may change quickly.
  3. Your options for responding effectively are probably greater than you know.
  4. You need a guide who knows you well for life’s critical decisions.


Taxes Have A Direct Impact On Your Bottom Line

Most of my affluent clients are deeply concerned about taxes. It’s not just that they don’t like paying taxes. It’s that they feel like taxes prevent them from growing their wealth to the level required for them to live the life they desire for the long run.

Suppose you have an outstanding financial year in terms of your investment returns, the growth of your business, and your overall personal net income. That’s a great feeling. But when a big tax bill shows up, that great feeling can turn sour very quickly.

This became apparent to me when I worked as a full-time CPA. I spent 10 years as a public accountant, showing clients their balance sheets year after year. What all of my clients wanted to see was the same: their assets on the left side of the sheet outgrowing their liabilities on the right.

When you subtract liabilities from assets, you get a statement of net worth. Net worth defines your true wealth picture, i.e., how much you are actually worth.  Most of my clients feel comfortable and secure when their net worth is equal to or greater than at least 20 years of their current living expenses. That is an important milestone to achieve.

But…paying big tax bills—especially bigger tax bills than you need to pay—makes this very hard to achieve. Taxes are a liability—a debt you owe. The more you can do to decrease the liability side of things, the faster the asset side of your balance sheet will grow. This is why you need a wealth advisor who is looking holistically at everything that impacts your net worth—particularly taxes—and not just investment returns.


Government Regulations May Change Quickly

Changes in tax laws and regulations can substantially impact the amount you pay in taxes. This is why you need a wealth advisor who is (1) carefully watching what is happening at the legislative and policy levels of government, and (2) is then taking proactive steps to protect your wealth from unnecessary taxation. If your wealth advisor does not have his or her thumb on the pulse of tax changes, it’s very likely you’ll be caught off-guard and either fall into avoidable traps or miss windows of opportunity that will not be coming back.

In normal times, it’s critical to understand how taxation impacts your net worth and to have proactively thought through strategies to lower your tax burden. But in times of significant political or policy upheaval, it’s even more important to be vigilant. You need someone who is closely watching the “effective date” of taxation matters to ensure that you are avoiding penalties and taking advantage of opportunities.  

Put differently, you need an advisor who stays on top of things and anticipates the changes you need to make before you need to make those changes. You need a wealth advisor who deeply understands your situation, your goals for wealth creation, and the range of options that might be available to you. But there is also something you don’t want.

You don’t want someone who is certain about what the future will bring. I sometimes hear prognosticators predicting the future with great certainty. I don’t believe in that: none of us can predict the future.  But you can—and you should—take steps to quickly respond to changes as they occur. My clients count on me to know what they need to do before they know they need to do it. They rely on me to keep a sharp focus on the changing landscape and bring them action steps to put them in the best possible tax position.


Your Options For Responding Effectively Are Probably Greater Than You Know

There is an unfounded myth concerning tax advisors that I would like to address. Advisors with a tax orientation are often thought of as rigid, straight-laced, by-the-numbers kind of people. That may be true of some advisors focused on taxes, but it’s not true of the best financial advisors who have a tax orientation.

Tax planning can be quite creative. If you are an affluent individual, your options for addressing taxation matters are probably greater than you now know. Let me give you a simple example.

Let’s assume that you have a regular IRA account, where there will be no tax on any income until you withdraw money from the account (presumably later in life when you are at a lower tax rate). In that account, you have $500,000 in U.S. stocks that are paying $15,000 of dividends a year. You feel pretty good about that.

Let’s assume you also have a regular personal (non-qualified) investment account. It also has $500,000 invested in it that is paying a dividend of $15,000 a year. This personal account consists of real estate stocks (REITs) and treasury bonds, both of which have gains that are taxed at about 40% annually. This costs you nearly $6,000 a year in taxes in real time. This, you don’t feel quite as good about. What can you do, or what might you have done, differently?

Here is one possible solution: suppose you had started with the real estate and treasury bonds in the IRA, and the U.S. stocks in your personal account. Under this scenario, you would be paying about 20% tax on the dividend gains from the U.S. stocks in your personal account, or about $3,000 on that $15,000 of gains, and paying no real time taxes on the real estate stocks and treasury bonds (that you otherwise would be paying $6,000 a year taxes on).

Essentially, you would have reduced your tax rate from about 40% to about 20% on the $15,000 worth of dividend gains you need to pay taxes on in real time, a savings of about $3,000 a year. Let’s assume you made this decision 20 years ago. That means you would have avoided paying $60,000 in taxes ($3,000 a year times 20 years).

But the corresponding impact to your net worth is not simply the $60,000 saved, assuming you had invested your tax savings effectively. Let’s assume you re-invest that $3,000 every year for 20 years and that you realize an average rate of returns of 7%.

  • By year 5, your net worth would be improved by $17,533 (not simply $15,000).
  • By year 10, your net worth would be improved by $41,877 (not simply $30,000).
  • By year 20, your net worth would be improved by $124,008 (not simply $60,000).

This is just one simple example of how the right tax move at the right time —combined with a good investment strategy and the power of compounding —produces much better outcomes for your net worth. There are many more complex tax-investment combinations that involve family trusts and partnerships, charitable trusts, Roth conversions and private placement life insurance that could significantly enhance wealth accumulation.  Some of these strategies reduce overall income tax to the family. Others shift wealth from one generation to another, thereby reducing death taxes. 

The kind of switch described above—starting out with the right kind of investments in the right account and changing little else—is not rocket science, but does take a bit of creativity and being on top of things generally. If you are not working with a creative wealth advisor with an orientation toward combining tax and investment options, you very well may be missing significant opportunities to grow your net worth.


You Need A Guide Who Knows You Well For Life’s Critical Decisions

The big changes in life can sometimes also have big tax consequences. Such changes might include retirement, selling a business, or coping with the passing of a loved one. Each of these situations brings significant tax issues and concerns. You need a wealth advisor who knows you deeply—your goals, dreams, and overall financial situation—to ensure you make the best decisions in these crucial moments.  

Let’s look at retirement first. Many of my clients think about moving to another state after they retire. There are significant tax implications that should be taken into consideration. For instance, Illinois does not tax pensions and IRAs.  Most other states that have an income tax do.  If you move to a state where pensions are taxed, it might make sense to convert to a Roth IRA before you make the move, since withdrawals from Roth IRAs are tax-free.  Depending on your federal tax picture, this move might substantially reduce your overall tax burden.

Consider selling a business. Cashing out at the wrong time can be very expensive. As this article is being written, many potential tax changes are in the works, potentially including changes in the capital gains rate. This might mean, for example, that you could pay 23.8% of capital gains this year versus 15% next year. That’s a big difference, and potentially a very good reason to delay the closing date for the sale of a business.

Or consider the passing of loved one. I’ve had several clients pass away over the last couple of years. Many of them had complex estates that were difficult to fully grasp. Fortunately, I was able to help their loved ones understand and be ready for the abrupt changes that were coming. This gave my clients great peace of mind that an additional unexpected tax burden would not be laid on top of their grief.

Had I not deeply known these clients, it would have been very hard to help their loved ones in the timeframe in which they needed help. This is yet another reason that I recommend that you start to build a relationship now with a wealth advisor who will get to know you intimately and always look at your situation holistically.


How Can I Help Your Family?

A great wealth advisor will look at your entire situation, including a balance sheet that shows your assets, liabilities and net worth. One of the best ways to grow the asset side of the sheet is to avoid paying unnecessary taxes by leveraging creative financial strategies.

The details of these strategies can sometimes be quite complex. But getting them right can make a huge difference in your balance sheet, your ultimate net worth, and your ability to live the way you want for the rest of your life.  If you don’t have a relationship with a wealth advisor who knows you well, and who is currently holistically assessing your situation for tax-related issues and opportunities, then let’s have a conversation soon.


The information contained in this article is provided for informational purposes only. No illustration or content in it should be construed as a substitute for informed professional tax, legal, and or/financial advice.