Tax planning in difficult markets: Creating silver linings when clouds are gray

When markets are challenging, your clients look to you to help manage their expectations as well as their hard-earned money. Your guidance can help them manage their emotions as markets gyrate and the value of their portfolio potentially declines. We all know about the importance of staying the course and remaining diversified.

Keeping your clients invested even in difficult markets is just one part of the value you provide them as their advisor. But you can also provide even greater value by taking advantage of certain tax-planning strategies that down markets provide. These could help your clients potentially reduce the taxes they pay on their investments. And that could go a long way to easing the pain of potential portfolio declines.

Tax planning checklist for difficult markets

Checklists are helpful tools to let your clients know you are minding the store even when markets go down. They help keep clients focused on what they can control even if only one or two items are available for their unique circumstances.  

Going through this checklist while having a conversation with your clients on the importance of remaining invested can also shift their focus from what the market is doing—which neither of you can control—to what you CAN do to potentially save on taxes or set the stage for a brighter financial future when markets recover. 

• Roth conversions – Revisit or start Roth conversion calculations as the tax cost to convert is lower when portfolio values decline.
• Tax-loss harvesting – Consider selling securities currently trading at a loss to create tax assets that can offset existing or future capital gains. If there are no gains, losses can be used to offset ordinary income of up to $3,00 per year. Be mindful of investment and risk implications, along with transaction costs.
• Tax-gain harvesting – Securities that have high unrealized gains may be sold if capital losses are available from tax-loss harvesting. If you have clients with highly concentrated single stock positions, the tax cost to reposition and increase diversification may be lower if the stock price has declined.
• Review inherited IRAs – Beneficiaries of inherited retirement accounts must fully distribute those assets within 10 years or be subject to a 50% penalty. When market values are lower, the tax bills associated with distributions may be lower depending on the client’s unique tax situation.
• Capital gains exposure – Capital gains distributions are an issue for taxable investors, and down markets add insult to injury when clients have to pay a tax bill from those distributions. Advisors who transition out of these funds prior to the record date may be able to minimize tax cost for investors.
• Tax transition strategies – Clients with tax-inefficient portfolios may be able to transition to a tax aware portfolio at a lower cost. It’s best to take advantage of the down market as soon as possible, to see if you can reduce future tax drag before the market recovers.
• Gifting of shares to family – This is beneficial to clients looking to reduce potential estate tax exposure. The lower the value of shares, the greater number of shares that can be gifted. The gift tax annual exclusion is $16,000 per individual.
• Gifting of shares to charity – For clients with charitable intentions, gifting appreciated shares as opposed to donating cash may result in a lower tax burden for the client and allow charities to receive the full benefit of the gift.
• Introduce direct indexing strategies – The modern client demands customization. Technology has helped us create custom suits at off-the-rack prices, and custom eyewear with a few mouse clicks. Direct indexing allows clients to build a personalized portfolio unique to their circumstances and preferences with the ability to help their overall tax situation.

The bottom line

Tax planning is an essential aspect of the advisor-client relationship. Retreating markets provide a window to potentially take advantage of lower tax costs to make changes to an investment portfolio. Silver linings in gray clouds, making lemonade out of lemons, dancing in the rain, whatever you want to call it—there are unique advantages to doing tax planning in challenging markets. After all, we can’t control the markets’ gyrations, and we can’t successfully predict market movements, but we can control what we do in down markets. Tax planning during these difficult times shows clients you are watching out for their best interests at all points in the market cycle.