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Why Financial Advisors Should Review Tax Returns

Tax return information can be used as a tool to help increase long-term wealth.

By Greg Smith

Yearly tax returns can benefit individuals financially, well beyond the refund check they may get in the mail. Tax forms can reveal a lot about someone’s financial situation, which can help structure financial decisions year-round. With the aid of a qualified financial advisor, tax return information can be used as a tool to help increase long-term wealth.

Many people work with an accountant to review their tax return, but they don’t always think to share it with their financial advisor. While accountants help with filing returns to earn the highest refund possible, financial advisors may look at returns from a different perspective. A tax return provides a financial advisor a more holistic view of a client’s financial situation and can be used to glean information to assist in future planning that goes beyond an individual retirement account deduction.

So, what can financial advisors learn from a tax return? These are a few of the areas I look at to help shed light on a client’s financial situation.

Interest Income

If there is a lot of interest income coming from a bank, this could mean the client has an excess amount of cash on hand, which could be better utilized to reduce risk. To even receive a Form 1099-INT from a bank, account holders must have $10 or more in interest income. If a banks’ interest rate is 0.1 percent, that means the account holder would have to have at least $10,000 in cash to generate a 1099-INT. So, if there’s income reported from a bank, it shows that the client has a large emergency supply of cash—and potentially even an excess, depending on how much interest income is being reported. In these cases, the client may want to consider investment options for some of the cash as a part of a long-term strategy.

Charitable Giving

Depending on a client’s age and retirement status, there are different options that can reduce taxes on charitable contributions. Clients over aged 70 1/2 who are subject to required minimum distributions from their tax-deferred retirement accounts can take advantage of a qualified charitable distribution. A QCD allows them to donate directly from an IRA to satisfy the RMD so that up to $100,000 is excluded from taxable income. For someone aged 70 1/2 or older who is required to take minimum distributions and who is charitable, their reported IRS distributions and taxable amount should not be the same number on their tax form.

Younger clients may want to consider creating a separate charitable donations account so that they may lump multiple years’ worth of charitable donations into one year to maximize their charitable deduction.

Social Security Benefits

Some clients view retirement as synonymous with applying for Social Security and apply for the benefit even though they have enough money saved to last throughout early retirement years. For those with enough saved, there are significant advantages to delay collecting Social Security. There’s a credit for delaying that can potentially boost expected lifetime benefits. For every year beyond full retirement age that someone delays Social Security, the benefits will grow by approximately 8 percent. So, if someone delays Social Security from aged 67 to aged 70, their benefits will be about 24 percent greater.

If an advisor all of the sudden sees a client is collecting Social Security, it’s a good idea to cross reference their age and benefit with their plan. Luckily, if the discrepancy is caught early on, an advisor can help reverse receiving benefits. I encourage clients to bring in their returns each year so that timely mistakes like this can be caught quickly.

Reviewing tax returns opens a greater dialogue between advisors and clients, which can lead to a more personalized financial plan tailored to someone’s financial habits and lifestyle. Aspects of finances that may not come up in regular meetings can be uncovered by studying the specifics of a tax return. And when it comes to financial success, it’s important to use every tool at your disposal—reviewing tax returns can help ensure that clients are on the right track.

Greg Smith is a managing director and senior financial planner with The Wise Investor Group at Baird in Reston, Va. Robert W. Baird & Co. Incorporated does not provide tax advice.

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