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Are you trying to learn how to deliver massive tax value to your clients? Then look no further. Retirement Tax Services Podcast, Financial Professional’s Edition is a show hosted by Steven Jarvis, CPA. Steven aims to bridge the gap between tax professionals, financial advisors and their mutual clients in their quest for reducing tax expenses in retirement.
Michael Henley from Brandywine Oak Private Wealth joins Steven on the show today to talk about delivering value to clients through tax planning, including the broad spectrum of tax planning services that can be provided and the specific services Michael provides to his clients. He also gives insight into the benefits and relationship dynamics of collaborating with a tax preparer and how that works for him.
Listen in to hear how Michael moves the needle forward for his clients, as well as why tax planning is such an integral part of the value they deliver. You’ll learn why he brought a CPA in-house, some of the specific ways he advises clients, and the analogies he uses to help them navigate a volatile market.
Steven and his guests share more tax-planning insights in today’s Retirement Tax Services Podcast. Feedback, unusual tax-planning stories, and suggestions for future guests can be sent to email@example.com.
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We’re not overpaying. No, we’re not overpaying. We’re not overpaying anymore. The tax code’s complicated, boring, and overrated. You don’t want that, you want a pro. One thing that you should know: this is a radio show. It’s not tax advice, don’t take it that way.
Steven Jarvis: Hello everyone, and welcome to the next episode of The Retirement Tax Services Podcast, financial professionals’ edition. I am your host, Steven Jarvis, CPA. And in this show, I teach financial advisors how to deliver massive value to their clients through tax planning.
As usual, I have a guest with me on this show today, and this is definitely somebody who is delivering massive value to their clients through tax planning. So excited to have Michael Henley, from Brandywine Oak Private Wealth, on the show with me today to talk about how he is delivering this value to his clients. So, Michael, welcome to the show.
Michael Henley: Thank you, Steven. I’m excited to be here.
Steven Jarvis: Yeah. So, to kind of kick things off, really, I’ve got two questions, we’ll go down. We’ll take them one at a time.
So, let’s start with tax planning is a really broad term and I’ve found that for some advisors, tax planning kind of means I’ll bring up Roth every once in a while, all the way to the other end of the spectrum of we’re really going to move the needle for you on what we’re doing as far as helping you save taxes.
So, for your firm, for you, what does tax planning mean to your clients?
Michael Henley: No, it’s a great question. And I would say that we kind of lead with tax planning. So, we start off almost every conversation, I would say that tax is almost run through our DNA.
Full disclosure, my dad’s a CPA, so I kind of grew up thinking about tax my whole life; right, wrong or indifferent, the child of a CPA. It’s interesting, starting my career at Merrill Lynch, I guess, some 10 years ago or so and doing my CFP, I’ll never forget going through the income tax module and realizing, gosh, I love this stuff.
Like line by line through 1040, for whatever reason, it was my personal passion. I loved it kind of knowing my own 1040 inside and out. So, it kind of became a passion or an obsession of mine, I guess, is the right word to use. Keeping up with Michael Kitces and Jeff Levine, all those guys.
So, tax planning, I would say, that for us, it is really how we move the needle with families. It’s a kind of a risk-free way or a very low risk way, deliberate tax planning of reducing our clients’ or kind of maximizing their after-tax returns, reducing their lifetime tax liability.
But more specifically, a lot of our clients are kind of conservative Dupont engineers and they don’t necessarily want to take explosive risk on the investment side. But they’re very much willing to on an annual basis or an ongoing basis, look at the math and kind of see, “Wow, if I can reduce my lifetime tax liability from 2.2 million to 1.6 million, or what have you, that additional 600 grand, I could either spend on my family making memories or B, give it to charity, give the organizations I care about.”
So, I think just by kind of laying out with numbers, kind of how valuable it really is — I’m just a big believer, Steven, as you know, that Wall Street focus is so much on the investment side and on trying to beat the market. And really, we’re all that kind of, all of the energy and effort trying to improve investment performance is not really where you can move the needle for families. So, we’re tax planning front and center.
Steven Jarvis: Yeah, I love that. And I think I originally heard it from Tom Gal, but I think you have a variation of the quote on your website as well, of kind of this idea that investments are a matter of opinion, like who’s going to pick the best stock, but taxes are really more a matter of fact.
And so, that’s a really interesting lens of knowing your client based on working with these engineers, these very analytical, these very conservative people from a risk standpoint. And saying, “Okay, maybe there’s more returns we could get them, but that’s going to be an uncomfortable thing for them. They’re going to always wonder about, well, what are you even doing with my money?”
But to get their heads around, “Wait a second, here are what the rules are. If we make these choices at these specific times, we can really easily quantify, here’s the difference in my lifetime tax bill because of what we did together.”
Michael Henley: Exactly. And I think that is so well-said. And Tom Gal, is exactly where I got that from. You’re exactly the right, investments are a matter of opinion. It’s a hundred percent fact.
I think a lot of it also comes to education and reminding the clients to look at market volatility. When the market is selling off as an opportunist, not a victim. Because your lifetime tax liability, Mr. and Mrs. Client is also on sale.
I try to explain in IRA is like an accordion; expands, you don’t want to pay taxes when it’s expanded. You want to pay tax when it’s contracting. You’re shrinking that. I think a lot of it’s going to be just trying to illustrate for the client, wait a second, this market volatility is a huge win.
We can reduce the client’s lifetime capital gains tax liability, reduce their lifetime income tax liability, kind of pay off our business partner, Uncle Sam, and kind of when the markets recover, our family keeps all of that rebound in the Roth versus in the IRA. We’re not going to share it with the government.
Steven Jarvis: Yeah, I really like that analogy. I think that’s a new one for me of comparing it to an accordion. That’s why I like having this conversation with so many different people, because I’m always learning new ways to explain this to clients. And depending on the advisor who’s talking or the client you’re talking to, having these different analogies kind of in your tool belt is really helpful.
And so, the idea of using the accordion, of course, it’s going to move. That’s the way it’s designed. It’s going to expand and contract. But instead of being scared of that, let’s understand what our best options are when it has contracted and what our best options are when it’s expanded. Yeah, that’s a great analogy.
Michael Henley: Even a minor kind of one on that, Steven’s interesting. Something we sent out recently to clients was around doing in plan conversions for clients’ children, the younger working years. If you’re in your twenties, early thirties working, or maybe you’re not in your peak earning years.
So, even doing something as simple as a 5, 10, $15,000 micro conversion, an in-plan conversion, telling, hey, the parents often will help pay the tax bill for the kids is what’s awesome.
Hey, if little Johnny will convert 50,000 of his 401(k) at work to Roth, you can also help pay that $10,000 tax bill as a form of gifting. So, the clients are like, “Wait a second, I’m going to improve my sons or daughters, financial position, long-term. I’m going to cover the taxes via gifting.” There’s a lot of kind of creative ways to cover the taxes on conversions as you know, et cetera.
Steven Jarvis: Yeah. Well, let’s take that example you just gave. So, that’s combining … I don’t mean this in a diminutive way at all. That’s combining relatively simple tax principles.
But you’re being creative with how they line up, because we’re taking our annual gifting limit of $16,000 per taxpayer, per individual. So, really, we could pay up to $32,000 even if they only have the one kid, but we’ve got two parents.
And then, this is really acknowledging — something that gets missed a lot is that, yes, it’s really common now that you can make Roth 401(k) contributions. And which means that we potentially have the opportunity to convert to Roth within the 401(k) plan, which is what you’re talking about.
But what people miss is that if I make a Roth 401(k) contribution and my employer matches my contribution, that match that employer or portion is not Roth, and this gets missed all the time.
Michael Henley: Bingo. All the time. Oh my gosh. Yep, you got it. It’s so common. Yep.
Steven Jarvis: Yeah, because it turns out the employer and as a business owner, I get where the logic is coming from; the employer wants their tax deduction for giving compensation to their employees, even if through a 401(k).
But people will be shocked by this. And unfortunately, especially since Roth 401(k)s are newer, you’re going to have these waves of people who, as they get to retirement, they’re going to continue to be shocked by let’s roll over my Roth 401(k), thinking the whole thing is Roth.
And then when they go to put it into an IRA or a Roth IRA, then they start realizing, “Oh, wait a second, I have this huge balance of tax-deferred money that I thought was all mine.”
Michael Henley: I think a lot of it is education, especially for the younger generation around tax diversification, which I know we talk a lot about. But just having three equal buckets when you retire, okay, I have pre-tax, Roth tax-free, and after-tax where you’re non-qualified. That allows me to manipulate the tax code and draw from whatever bucket is the most efficient.
The example I use with clients is often if we have a far left, let’s just say, Elizabeth Warren in the White House and tax rates are 70%, I’m going to draw it on my Roth money. If we have a far right, Ted Cruz and tax rates are 10%, I’m going to draw it on my pre-tax money.
So, you’re really able to kind of manipulate your after-tax monthly income in retirement, in the most efficient manner with multiple buckets to draw from. The optionality is something that’s often not talked about enough, but it also kind of comes back to the same similar talking points.
Steven Jarvis: Yeah, that’s such a great point. Because one of the things I like to stress both to clients and as I’m working with advisors, is that tax savings are not the only reason to consider Roth conversions, and getting money into Roth. Tax flexibility or I think it was either Ed Slott or Jeff Levine at a conference, I went to last year that basically called Roth, like basically your tax insurance.
It’s not just about doing the math and coming out to the exact dollars and cents that we need to put into a Roth to have this maximum outcome, it’s “Hey, let’s look at it from a broad perspective and say, hey, if we could fill up this bucket that the IRS can’t change the rules on later, would that help you feel better about getting ready for retirement?” And the answer for pretty much everyone is, “Yeah, of course.”
Michael Henley: Yep, totally agree. I really think quite frankly, not enough advisors by far are looking at the client’s tax returns and you talk a lot about that. That is something that to me, I would say, even back when I was at my former firm at a big wirehouse where they don’t allow tax planning, per se, I would ask for a copy of the client’s 1040 every single year without fail. We had them all electronically just to review, if nothing else, to avoid catastrophic errors.
So, here’s a real-life example, a capital gain, the CPA reported $300,000, not $30,000; client overpaid, federal and Delaware taxes. I mean, literally this is a real-life example where — this is like early in my career.
And I said, oh my gosh, very eye-opening, as a CPA out of his garage, not like a real professional, I think it was like an EA kind of working from home part-time. And a friend the client, not a big deal, but that type of oversight, I mean, jacked up Medicare premiums
All the ancillary effects trying to get them unwind the darn thing, just an example, you have to as … one of your key roles as far as I’m concerned is managing the client’s entire financial life, including their tax return. It’s just too often overlooked.
Steven Jarvis: Yeah, I completely agree. The piece in that that’s getting missed is that your planning means nothing if it doesn’t get reported correctly. Which is exactly what you’re talking about. We’ve got to see it all the way through to getting reported to the IRS.
That’s one of the reasons that when we designed how we work with advisors at Retirement Tax Services, one of our steps in our process is that we provide draft returns to the advisor so that we have that other kind of last double check.
The advisor, we’re not asking the advisor to take on the liability of us signing the tax return. But even if we set mistakes aside, they’re just tax forms that don’t really help tax repairs out 1099s are really not all that helpful.
And so, as we were going through taxes this year, there were multiple occasions where our team technically did the return correct based on the information we were given, but when we sent it to the advisor, they were able to provide additional context.
“Oh, actually, here’s some things you should know.” And we said, okay, great. And then we got it done right the first time, and then we’re not amending returns. We’re not going back and saying, actually it shouldn’t have affected their Medicare brackets.
And that’s in the best-case scenario. There’s also the cases like you’re talking about where we have a friend of a friend or our favorite uncle John, who’s doing our taxes and accidentally types in an extra zero or two.
Michael Henley: And I think that these are great examples, Steven. Honestly, I think advisors needs to ask themselves, “What percent of my time should be spent on tax planning, tax modeling, all this stuff. And what can I outsource?”
Because most advisors should not be spending two thirds of their time. I have friends of mine that are either at Merrill Lynch or Edward Jones, or what have you. And they often will spend — they’ll say, “Oh my gosh, this week, half my week has been on looking at these couple clients tax returns.”
And my advice is outsource that, hire RTS, hire a professional that can look at this for you. Because honestly, their job is to build relationships, build rapport with clients, give clients outcomes to what matters. They should not be spending two thirds of their time doing tax planning and modeling.
So, I think it’s something the advisor has to decide, “If I want to make this part of my business, do I want to undertake 5 or 10 years of studying and trying to learn this stuff inside and out? Or do I just want to say, let me partner with a professional that can kind of take this on for me?”
Steven Jarvis: Yeah, let me hit the easy button. That’s exactly how we look at it of financial advisors are smart people, especially when it comes to numbers. Hopefully, all the CPAs listening can just cover their ears for a second, but taxes are not so individually complex that I couldn’t teach them to most people.
But this is about highest and best use. And so, even at RTS, we’ve become Holistiplan super users because Holistiplan is a tool we can use to kind of expedite the process a little bit, get some of that initial summary done for us, get us kind of started in the right direction. And then we layer our expertise on top of that.
And so, now, I spend less time gathering data and doing that initial data review and I can jump right to let’s get into these creative strategies, let’s get into action plans, let’s get into some of these other things. And so, there’s tools that you can use along the way, for sure.
Michael Henley: Agreed. I think quite frankly, advisors, they almost need to remind themselves that, hey your job is to compel someone to take action. Take action, implement the strategy. Your job isn’t necessarily to report the strategy, but you’re absolutely right, I think the point you made Steven is so valid. The most advanced sophisticated strategy means nothing if it’s not reported correctly in the first place.
10 years of HSA deductions for 55 to 65 is awesome. But if you don’t report … early on in my career, I had clients, not the CPA, just wouldn’t report them at all. I give them the proper forms, wasn’t done. What good is it? There’s no tax deduction. So, it’s a kind of going back and amending returns is not a lot of fun either.
Steven Jarvis: No. And as we’re recording this episode, just this last week, the IRS report came out that the IRS is now 21 million paper returns behind with their backlog and amended returns typically end up in that pile.
And so, yes, we want to do everything we can to avoid amended returns. Let’s take that extra step, make sure this gets done right the first time, make sure as the advisor, things that you can do; you’re sending out a year in 1099 letter, RTS members have a copy of ours that we use.
You’re proactively communicating or you’re just fully partnering with someone, whether that’s RTS or another tax preparer to make sure that that communication is there, that it’s effective, and at the end of the day, it’s serving the client. That’s who’s ultimately going to win here.
Michael Henley: Relative to like working with CPAs in general, partnering with CPAs, it’s interesting how … I look at them, I kind of evaluate that and say one thing I look at is kind of, if an advisor has 30 CPAs, let’s say in their book of clients, that often can become problematic because they have different processes all of them. They all kind of focus on different things. Some believe in Roth conversions, some don’t. Some believe in tax diversification, some don’t.
So, often, I think trying to be mindful of these CPAs in your network can also be sometimes helpful from the advisor standpoint.
Steven Jarvis: Oh definitely.
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Steven Jarvis: Switching gears just a little bit, I get advisors who will get excited about this idea of bringing tax preparation in-house, which as much as I want RTS to be the answer for every advisor, we’re never going to get so large that we can serve all 300,000 advisors.
So, I’m okay with there being other solutions out there. In fact, you have hired a CPA in-house, you do tax prep in house for your firm. So, I’d love to hear a little bit about your experience and whether that’s something that you would recommend to other people.
Michael Henley: I’m happy to talk through it. So, we started a tax practice last summer, basic tax preparation business. And the reason that we did was simply to alleviate errors. We found that we were spending too much of our time; how much time are we spending on this sort of thing — reviewing client tax returns and working with our outside CPAs to fix the errors they were making.
So, constantly, the conversion was reported wrong, the donor advisement was reported wrong, whatever it is. So, a lot of our time was spent going back and forth on errors being made by CPAs. So, we said, okay, if we can bring this in-house, that’ll make things much more efficient by all means, certainly.
But we wanted to make sure that the CPA we brought on, naturally, younger in their career, there are a lot of kind of caveats there. I would say that by and large, I don’t think the majority of IRAs or advisors should be doing tax prep. I think it’s kind of a unique part of the business. It’s not hugely profitable.
It’s a question of, how do you charge for it? Do you wrap it into the AUM fee? Do you not? We charge separately for it. But it can be a mess. It can be very complicated. And as that business continues to kind of scale, you’re going to naturally have the tax business grow in one direction, IRA grow in another direction.
If you ideally want every one of your IRA clients to use your tax prep, your tax preparation business to the extent they can. However, the client’s very happy with their CPA. There’s nothing wrong with that either.
So, I just think advisors need to be mindful of what it’s going to take to go into it. The pros and cons of it. And do you go as far as bookkeeping? Do you only handle retirees? Do you do self-employed folks also? Do you do business returns and corporations and all that fun stuff?
So, I just think you have to go in eyes wide open. I think advisors by and large, the most of their time is best spent giving clients outcomes to what matters, in terms of what matters in their life. Kind of “Okay, I want to buy that second home in Antarctica. Okay, how do we make that happen?” “Here’s how to make it happen in the most efficient manner, here’s how much I can afford to get the charity,” all that kind of permission to spend more, et cetera, et cetera.
I just think that’s really where advisors time is best spent. I think partnering with ACB would certainly be helpful. I just think that it opens up a can of worms that in my experience, I’ve talked to a number of advisors, who’ve done it kind of both ways and where often they land is they started a tax prep business. It took over the entire IRA.
Let me use a real-life example. My friend of mine out in Chicago, he has a billion-dollar IRA, great. But the tax prep business, they bought, I think four tax prep, businesses all at the same time thinking, “Oh, we’re going to kick this thing off.” And I think it was like …
So, just for perspective, now, the IRA is 10 people strong and the tax business is like 30 people. So, basically, he says, “I’m managing … it just gets to be this mess of, well, the revenue still comes to the IRA. It just gets to be a mess.”
So, I think that long story short, advisors would be well-served. Just think about, “Okay, does this make sense? What am I trying to create here? Am I also going to open a law firm and offer to do their estate planning doc? Am I also going to open an insurance agency and do all their property and casually?” It’s a slippery slope.
Steven Jarvis: I definitely know a lot of advisors who have gone down that road, who have explored it. And there are situations where it works out great. It’s not that it can’t work, but to your point, it’s very different business models.
And I definitely know more advisors who started with a CPA or EA tax prep background, got into wealth advisory, and then left behind the tax prep. Or they’re only doing tax prep for their top clients.
I’m double checking. I’m just kind of thinking back through this, but I don’t know a single advisor who has gotten to a point where they said, “You know what, I should focus on the tax prep side and let’s start minimizing the planning side.” Please, if somebody’s listening and has that experience, reach out to me, I’d love to have you on the podcast. I don’t know anyone who’s doing that.
And I say that as the co-founder and head CPA of a tax preparation firm. But we intentionally set our firm up to be as different as possible. That’s why we have such an emphasis on planning. That’s why we don’t just do preparation on its own.
We’re only working with people who see the value and will engage in the planning process with us. We only engage right now with taxpayers who also work with an advisor in our networks, we know that collaboration is going to be there.
And we’ve really narrowly defined who we’re going to work with. So, we’re not doing expats and we’re not waiting into crypto trading and we’re not doing large businesses. And these different things where we can stay really narrow and say, here’s who we have served really, really well. And we know we deliver a ton of value.
Michael Henley: I think quite frankly Steven that is what most advisors need. I would speak broadly about the industry. There’s so many advisors at these big wirehouses. I’m friends with a lot of them, I work with a lot of them lot, a lot of them were at my wedding.
And basically, I can say directionally, it just something as simple as they take the standard deduction, the advisor I’m talking to now — have them just do a QCD, they’re 77-years-old, it’s $5,000 to their church. It’s so simple. It sounds like it’s so minor and obvious, it is not obvious. They’ve never been trained on tax. These advisors are old school, a lot of times stock brokers, a big wirehouse, it’s okay.
But they’ve just never had that — never seen through the lens of a 1040. I’ve had a number of situations where the client’s on the cusp of Medicare tier, they’re giving like 8,000 bucks to their church, and guess what? Just do a QCD. Oh my gosh.
And it’s just means it’s a couple hundred dollars’ savings or what have you for the year. And it’s just something as minor as that, the clients care about that sort of thing. And it’s just having someone to look through the lens of the 1040, I think is so critical, where often, advisors never look at the tax return in the first place. It’s not their job, according to the big banks.
I also want to push back on one thing I think is helpful, just for the audience. I was an employee at one of the biggest firms and I can assure you, I was doing tax planning then. You were not just allowed … I was giving Roth conversion advice. I was saying, hey, tax diversification.
You can’t do tax software … I don’t think Holistiplan would’ve flown at some of the big firms. But I just think you can absolutely be giving it tax guidance. Maybe not filing the return, but I never had an issue just kind of educating the client on tax buckets, et cetera. And I had some of the most difficult compliance managers, I think in the industry.
Steven Jarvis: Yeah, what I’ve found is that for advisors who are really committed to it — and when I say committed to it, they really see the value to their clients. At the end of the day, it’s a huge value to clients, which also means it’s a huge value that your prospects are going to see that will help them become clients.
Even at some of the biggest firms in the country, some of our RTS stuff is getting compliance approved by those advisors who are really committed to it. They’re taking the time to work with the compliance department and say, “Here’s the value to the client, you just tell me how I need to communicate it.”
So, that this isn’t going away. We’re seeing more and more, even if it’s very small steps, very baby steps, we’re seeing more and more of the big BDs and wirehouses take these baby steps to allowing advisors to do more of that. And so, really, it’s up to the advisor to just lean in and make sure they’re doing it the right way.
Michael Henley: I think the point really is if you’re at a big firm, there is no excuse. You have no excuse … well, I’m not allowed. Basically, you should be doing this as a fiduciary regardless. I think it’s something that is critical.
Steven Jarvis: Well, and to kind of tease something that’s going to come out later this year, we are actually working with an attorney to collaborate on a white paper on the difference between tax advice and tax planning.
Because this is something that comes up all the time of, “Oh, I can’t do that, that’s tax advice.” And then we go and say, “Okay, well, what’s your definition of tax advice?” “Ah, well, I’m not really sure, but that just feels … it’s kind of like if you see it, you know it”.
And it’s like, I don’t think you do. I think everyone has a different idea of what tax advice is that we’re going to take the time and write a well-researched and white paper style kind of report of here’s everything we can find of where we think this line is.
And we’re going to go out and get feedback from people in the industry who talk about these kinds of things so that we can at least point people to something to say, “Well, this is at least our idea of the difference between tax planning and tax advice, where do you fall?”
Michael Henley: The other thing I think is really, you can marry the two. As a financial planner, you can marry kind of the investing on behavioral finance concepts with the tax side, which is so awesome.
So, like right now with volatility, a lot of clients, let’s just say they have this behavioral urge to do something. The market’s on sale, NASDAQ’s 30% off the highs. They want to do something.
Okay. If we convert to Roth with NASDAQ 30% off the highs, when we recover the loss, it’s a 45% return tax-free in your Roth. It scratches that itch, they want to do something.
In other words, like if we shift short-term treasuries from their IRA to their Roth, buy the entire market on sale off a third, it’s that itch they have of, okay, it’s not market timing, but they’re taking advantage of price. So, basically, I think that sort of thing, you’re able to kind of scratch the behavioral itch of wanting to … with that tax savings as well.
Steven Jarvis: Yeah. That’s a great point. You’re right. Nobody likes sitting back and doing nothing, especially when they feel like the world’s coming down around them.
Michael Henley: And what we do right, wrong, or indifferently, we have kind of plan A, plan B and plan C with clients. So, we’ll show them if the market is down 0 to 15%, let’s say a normal correction, we’re going to convert plan A. So, we may fill the current tax bracket, next Medicare tier or whatever it is.
Plan B is the market’s down 20 to 40% a major, let’s say a bear market in the eyes of CNBC. And that’s going to convert maybe twice much fill, maybe fill the 24, maybe Medicare, maybe out the window for one year.
And then if we get a major, let’s have 40% off the highs, a 2008 type crash, we’re going to convert a significant amount. So, we’re going to look at their overall estate plan, charitable intent, et cetera.
But we did a number of million-dollar conversions in March of 2020 that happened to be timed fairly well, maybe some 500,000, some a million. And those clients are ecstatic. Their Roth’s now two and a half million, some of them, the big ones.
And basically, they’re like, “You got to be kidding me, this is …” And they kind of see this again. And so, guess what, a lot of the same clients want to do this time around? Same big conversion again.
We don’t know where the bottom is. We tell them that we’re going to dollar cost average the whole way down. We don’t know where the proverbial bottom is, but we do know that when the market’s this far on sale, your taxes are also on sale. I just think that combination is certainly helpful.
Steven Jarvis: Yeah, that definitely raises a couple of questions for me that I’d love to get your thoughts on because I think I heard you say in there that you had people in 2020 do a million-dollar conversion. Which is real simple math that most likely is pushing them into the 37% bracket.
And a lot of the traditional conversations around Roth conversions really focus on like the 12, 22 and 24% brackets. But you’re saying there are situations where you’re telling your clients yeah let’s convert to the absolute highest bracket.
Michael Henley: Yeah. And also, that’s a function of a couple things. One is probably my personal position, I think tax rates only have to go up. The debit’s out of control. So, I just think tax rates, I have a hard time with them being much lower in the future.
Number one, number two, in Pennsylvania here, we have a lovely estate inheritance tax. So, if I pass a million-dollar IRA to my daughter, Savannah … I’m going to leave Maverick up for a second, he’s going to kill me later.
But basically, she’s going to have to pay ordinary income tax and a four and a half percent, like a 5%, 50 grand to Pennsylvania no matter what. So, it’s that grossed up value of a million. If that Roth were 650, her inheritance tax went down by a third. You know what I mean? So, it’s almost a … so, in Pennsylvania that helps.
But I would say that for us, it’s often looking at the tax bracket of the kids. So, we kind of evaluate the Roth conversion, A, tax bracket if the client’s married, and the tax bracket of the widow or widower, the tax bracket of the kids.
And very often a lot of our clients have successful kids who may be in New York, in California, and Massachusetts, in high tax states. If they’re in Pennsylvania where Roth conversions or income tax-free here in Pennsylvania, retirement income is not taxed in Pennsylvania, it’s really cool because … they are cool in my world —they can basically divert Roth income tax-free on the state side. And basically, kids are already in top tax bracket.
And then secondly, the other group of clients I’m thinking of Steven, are clients that are subject to a state tax. They may be worth 10, 15, 20 million, and they may have a 3 to 5 million taxable IRA.
And the thing I always want to be able to do is look my clients in the eyes and tell them “Your kids will never be taxed at the estate tax, income tax level and pay 65% tax.”
That’s the challenge I have is that basically, if they’re already going to hit with an estate tax and that 40% clip, that 40% haircut, and an income tax haircut on top of that is just something that we just feel pretty strongly about trying to avoid if possible.
Steven Jarvis: It’s such a great approach, because you’re talking about kind of some of the steps in the process, but the philosophy that drives that is that tax planning has to focus on the lifetime of your client’s wealth, not even just their lifetime.
It certainly isn’t a conversation of how do we do tax planning for this year for 2022. And really, it’s not even just a conversation of, well, your life expectancy is 20 more years, let’s do tax planning over that.
It’s understanding what happens next? Do they have kids, grandkids? Are they going to leave it all to charity? There’s a lot of different options here but there are significant dollar amounts at stake of choices that are available to us if we proactively plan.
Michael Henley: And especially for those clients who say I’d like to leave part of my wealth to my kids and grandkids in the form of a, let’s just say a discretionary trust, to the beneficiary — a Roth IRA is an unbelievable vehicle to leave a tax protected tax-free pension, basically to the grandkids.
You can basically set it up. It’s incredible 10 years’ tax-free compounding, discretionary distributions, but they can be their own trustee. And there’s a lot of really creative plan that can be done to kind of not recreate the stretch per se, but at least leave them a tax-free kind of credit or protected pension that is protected from divorce.
So, their own trustee, keep it in the trust. There’s a lot of things that you can really do that with an IRA, a taxable IRA, it’s just not as attractive. It’s just not nearly the same.
Steven Jarvis: Yeah. So many great things in there. I really appreciate you sharing your perspective and your approach to all of that.
Michael, as you very well know, information without action is worthless. I know that you kind of have a personal habit of going back to things that you learned from and making sure you’re really implementing them. So, I know that you’re fully on board with that.
So, we want to make sure that people listening to the podcast are taking action on this conversation and not just sitting back and listening to us nerd out on taxes. So, as you think about the things that we’ve been talking about, the things that you do in your practice, what are action items you would recommend to listeners who want to level up their tax planning game?
Michael Henley: So, one of the things I would say, one of the HSAs, make sure you’re looking at clients’ HSAs, 365, everybody misses it. I don’t know what it is. HSA has become very powerful. Pay cash to medical expenses, hold onto your receipts. Grow a tax-free, it’s like a Roth IRA, long-term … kind of in the latter half of retirement, think about using HSA then, when you’re in a higher tax back because of forced RMD, social security call adjustments, et cetera.
The second thing would be reviewing your client’s estate documents. So, I would say that reviewing your client’s estate documents specifically for charitable bequests. We identified a number of clients who were leaving 50 to $500,000 to charity as part of their estate plans. They have significant pre-tax IRAs.
They are much better off carving out the beneficiary form of the IRAs and leaving fully taxable IRAs to charity to kind of optimize. They get a hundred cents on the dollar that charity does versus individuals getting 65 cents.
I just think that is something … we’ve went through that Steven two years ago, it was very eye-opening, learning more about the client’s charitable bequest after their lifetime; encouraging QCDs while they’re alive. But more importantly, engaging the attorney and saying, “Hey, what do you think about changing the charitable bequest to their IRA dollars instead?”
Attorneys love it. Attorneys generally don’t do much in the way of tax planning. So, basically, they eat it up and CPAs love it. If we engage the attorney in the CPA, the CPA’s like, “Oh my God, I love this, and here’s why.” And the attorney is like, “I’d never thought of it.”
Just something I think was very eye-opening for us, I would highly recommend advisors, think about that.
Steven Jarvis: That’s great. And I wish I could take credit for asking you to plant that seed. But my guest next week on the podcast, we’re going to talk all about HSAs and super HSAs, which is something I recently learned about. I’m really excited to talk about.
Michael Henley: Yeah. Kelley Long?
Steven Jarvis: Yes, exactly.
Michael Henley: Oh my gosh. Kelley, she’s a rock star. She’s a total rock star. I’m a huge fan. That super HSA thing, oh my gosh. Your audience-
Steven Jarvis: Yeah, don’t ruin it. That’s next week’s episode, but definitely come back next week. Listen to that one, it’s going to be a really good one.
Love the recommendation on looking at the estate documents. And the one I’ll tag on that I think came out of a lot of this conversation today is make sure that you are being intentional with communicating on whatever strategy that it is you’re implementing.
Not just communicating with the client, communicating with the tax preparer, making sure this gets reported correctly. If it doesn’t get reported, your tax planning, isn’t adding value to your clients.
Michael, thanks so much for being here, coming on the show today. I really appreciate all your insights.
Michael Henley: Yep. Remember one last thing, Steven, it’s not net worth, it should be called net keep; what you keep after taxes is what matters.
Steven Jarvis: Net keep, I like that. That’s right. We got to focus on that net keep.
Alright for everyone listening, until next time, good luck out there. And remember to tip your server, not the IRS.
We’re not overpaying. No, we’re not overpaying. We’re not overpaying anymore. The tax code’s complicated, boring, and overrated. You don’t want that, you want a pro. One thing that you should know: this is a radio show. It’s not tax advice, don’t take it that way.
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