As we start 2022, there is still a lot of uncertainty in our lives, even beyond the ongoing pandemic concerns. The investment markets have started off the year with a lot of volatility, interest rates will be rising, and inflation is high, Congress is dysfunctional and we have no idea what may happen with tax changes in the near future. It is easy to get caught up in the wild swings of things or be frozen by indecision in times like these. All of this makes it that much more important to step back and think about your clients’ overall financial planning and goals to make sure their planning is where it should be.
On a recent AICPA webcast I moderated with Scott Sprinkle, Michael Goodman, and Sue Stevens, we discussed key issues as we start the new year. Here are some of the planning ideas we discussed.
Income Tax Planning
Since we don’t know what changes might be coming, it is best to plan based on what we currently know. It might be helpful to think of the December 2021 tax proposals set forth in the Build Back Better bill as a “worst-case” scenario. While we can’t predict future tax rates, doing multi-year tax planning is a key part of your overall planning. Looking for planning opportunities and lower-tax bracket years can help reduce your tax liability over the long term. One aspect of tax planning is to make sure you know what cash is needed for taxes and when. With the strong equity markets of 2021, you may have larger than usual capital gains or capital gain distributions that will drive up your tax liability in April. Managing those cash flow needs is very important.
Capital gain planning is still important, even though at this point it does not look like rates will rise anytime soon. With the wealth that has been created in recent years, and the fact that we have seen such strong performance in certain areas of the equity markets, one can often have highly concentrated stock positions. Considering strategies to address this is an important part of tax planning. Capital gain harvesting, exchange funds, and charitable remainder trusts can be good tools to manage this.
Roth conversions might make sense, even at tax rates higher than you typically would think, if rates will be higher in the future. If you can convert IRA dollars into a Roth, not only are you creating a tax-free vehicle for you and your heirs in the future, you are also reducing future required minimum distributions (RMD) from the IRA starting at age 72. Often these RMDs will push you into higher tax brackets
Charitable giving is even more important for many clients now and still a very good tax planning tool. You must decide whether to make your gifts with cash or appreciated securities and also whether to fund them from your IRA with Qualified Charitable Distributions (QCD) if you are over age 70 ½. You can also look at the advantages of a donor-advised fund as a vehicle to manage the timing of your charitable contributions.
Planning conversations about end-of-life planning certainly seem more relevant in these pandemic times. Make sure your documents are all current and your family and loved ones know what your desires are.
It is important to think about estate planning differently for those at different asset levels. If you are under the current federal estate tax exemption amounts ($12,060,000 per person) the focus may be on making sure your assets will pass the way you want them to upon your demise. Everyone should be thinking about who they name for key roles in their estate plan ––executors, trustees, etc.
Last fall, it seemed as if we would be facing an acceleration of the reduction of the estate tax exemption (which is scheduled to drop in 2026), but now that does not seem as likely. We were also facing the possible elimination of numerous planning strategies used by high-net-worth families–valuation discounts, grantor trusts, low-interest loans, etc. If you are over the current exemption amount and you can afford to shift assets out of your estate from an asset sufficiency standpoint, taking advantage of these kinds of strategies while they are still available makes sense.
If you are funding education for children and grandchildren, 529 plans can still be an excellent tool and method for shifting wealth to future generations. The tax-free growth and ability to take distributions without any tax consequences for education purposes are great and, if they are “overfunded,” remember that they can be held and used for other family members or future generations’ education expenses.
We often find that getting back to basics in the investment area is critical in strong markets, as well as when volatility hits. Making sure your asset allocation is in line with your targets and that it matches your risk tolerance and return requirements is key. Why take on more risk than necessary to reach your goals? It is better to focus on the rate of return you need to earn to meet your goals. Discipline might be the most important investment strategy in 2022!
With much of the strong stock performance concentrated in a small number of stocks and sectors of the market in 2021, it is easy to get out of balance with your target allocation. It is also important to think about “asset location” –what you hold in taxable vs. retirement accounts (and Roth IRAs as well) as this can help to improve overall returns.
Many people struggle with the reasons to hold bonds in a portfolio in this very low-interest-rate environment, especially if rates will rise this year and bonds could lose principal value. They often reach for yield in times like these, taking more risk than they realize. Bonds provide stability in your portfolio, especially in times of volatility on the stock market. They can also provide income, albeit a small amount at today’s rates.
With the combination of recent high-equity returns (at least until this year) and low-interest rates, resetting the rate of return expectations in your planning might be in order. The pandemic has also changed many of our spending habits and so revisiting your cash flow needs, now and in the future, might be in order. We have also seen many clients who are reassessing their personal “life planning” goals in light of the pandemic, thinking more deeply about what is really important. This perspective on what is really important may have changed and that needs to be incorporated into your financial planning.
We have also seen many people rethink where they want to live. Real estate markets have been pretty crazy lately and making sure your goals in this area are part of your overall planning becomes very important. With interest rates still (for now) relatively low, managing the liability side of your balance sheet is also important and can present opportunities with good planning.
It is important to not overlook this aspect of your personal financial situation. With increased natural disasters, rising home values, and changes in the insurance markets, revisiting your property and casualty coverage is important. Reviewing your life insurance coverage is another aspect that people often overlook as time goes on and their financial situation changes. The long-term care (LTC) insurance field has changed dramatically in the past decade with many companies raising rates and others going out of business. If you have LTC coverage, make sure you understand the details of your policies.
When you think of risk more broadly, cybersecurity becomes an important concern for everyone. We can’t emphasize enough how important it is to make sure you are protecting your assets digitally and being extremely careful as cyber criminals are always looking for opportunities. Freezing your credit may be a good idea if you don’t foresee the need to rely on that credit source in the near future.
The beginning of the new year is always a good time to review your financial planning situation. This is especially important in times like these when the uncertainty caused by the ongoing pandemic, investment market volatility, and changing priorities come into play.
- Lyle K Benson Jr., CPA, PFS, CFP
The views expressed represent the opinions of L.K. Benson & Company and are subject to change. These views are not intended as a forecast, a guarantee of future results, investment recommendation, or an offer to buy or sell any securities. The information provided is of a general nature and should not be construed as investment advice or to provide any investment, tax, financial or legal advice or service to any person.
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