RTS #006 – Psychology and Taxes

It turns out I’ve been right all along! At least, that’s the way I’m going to interpret the interview I had last week with Meghaan Lurtz, a Financial Psychologist doing incredible work around Financial Planning.

Anecdotally I’ve noticed for a long time that taxes are incredibly emotional for people. More so than investments and many other areas of their financial lives. This is something I’ve been able to observe, but it turns out there is science that backs that up, and it’s not just me seeing what I want to see.

Our brains are wired for loss aversion. That means our nature prompts more emotion around saving a few bucks in taxes (what we perceive as avoiding loss) compared to an exponentially larger return on investments. This means that tax planning will be viewed by your clients as more valuable than most of the other work you do, even if the tax savings from a dollar standpoint are relatively smaller. There will always be exceptions, but Advisors already helping their clients with tax planning can likely think of cases where they’ve already seen this to be true.

Of course, to do great tax planning, we need to get our clients talking about tax planning, which usually isn’t a topic that elicits a great deal of excitement. In fact, it’s easy for questions about taxes to put people on the defensive. Most people have “grown up” under the impression that taxes are something we all should understand since DIY options are so widely available. This means that how we communicate about taxes is critical.

Another area that I’ve always felt strongly about and now have the science to support is around setting expectations with clients upfront to help influence the outcome of the planning we do together. In our interview, Meghaan talked about this in terms of “anchoring”, which again is backed by science and tells us that our initial point of reference will affect how we feel about an outcome. So if Bob and Sue think tax planning means saving $1,000,000 in taxes and we don’t reset that expectation, anything short of that will be a failure.

To be successful with tax planning, we need to understand a client’s emotions attached to it, help them set the right expectations, and then, of course, we have to be able to help them execute on the strategies that will help them realize the benefits of proactive tax planning.

What can you do about it?

With any planning, and certainly, with tax planning, you have to set expectations upfront. Practice asking questions about a client’s tax situation before diving into the strategy you think is right for them. The way those questions are worded is crucial, it’s not enough to get it “mostly right.” The scripts we use have to be rehearsed to the point that they come out the same way every time and have a positive impact on the work we are trying to do together.

Listen to last week’s episode of the Retirement Tax Services podcast for examples of the wording that I use with clients.

Happy Tax Planning!

About The Newsletter

The tax code is 80,000+ pages and Google has 875,000,000 results when you search “Tax Planning”, so each week we are going to help you wade through all of that noise and get to the Relevant Tax Stuff.