RTS #013 -Dealing with tax misinformation

We don’t claim perfection, but we put a lot of time and effort into making sure our content is relevant, accurate, and impactful. That is not universal across the internet! While you may have a strong BS detector and avoid people who are either ignorantly promoting bad tax advice or intentionally exaggerating the potential benefit of a strategy to inflate their social media business, not all of your clients do.

Just last week, someone forwarded an article to us proclaiming that less than 1% of taxpayers would ever benefit from using Roth accounts. That the average taxpayer is losing around $163,000 to the IRS by electing Roth and that the author had personally lost over $400,000 by funding a Roth account…that’s the kind of nonsense you are up against at times. Rather than go down the rabbit hole of poking holes in all of the incorrect and misleading claims in an article like this, we are going to stick to providing great tax information as often as we can (and we strongly encourage you to do the same).

One great way you can do this with your clients is to proactively answer the most common questions that you have to educate your clients on. Here are three we’ve been getting recently and our thoughts on them:

1. If I choose Roth over a taxable brokerage account, don’t my beneficiaries miss out on the step-up in basis when I pass away?
   This question has primarily been coming from Advisors, but in our experience, if Financial Advisors struggle with the concept, so do taxpayers. Roth accounts are tax-free for beneficiaries. While not technically referred to as a “step-up in basis”, the beneficiary of a Roth account does not have to worry about paying tax on any capital gains while the holdings are still in the Roth account. All earnings, whether interest, dividends, capital gains distributions from mutual funds and ETFs, or capital gains from the sale of securities, are all tax-free. “Missing out on a step-up in basis” is NOT a valid reason for choosing taxable over Roth.
2. Doesn’t the 10-year rule on distributing inherited Roth IRAs create tax issues compared to inheriting a taxable account that has no time restrictions?
   Inherited Roth IRAs do have a requirement to be distributed by the end of 10 years. But rather than a downside, this is a huge positive. That means that the beneficiary gets an extra 10 years of tax-free growth. On day one of inheriting the account, the value to the beneficiary will be the same, whether it’s a taxable account or Roth, but the two sharply diverge in tax treatment from there. Any additional dividends or growth in a taxable account will be taxed, but the beneficiary of a Roth account gets up to 10 additional years for the account to generate income and growth completely tax-free.
3. What about charitable giving? Does Roth remove my ability to gift highly appreciated stock?
   The double benefit of donating appreciated stock is that you get a tax deduction AND get to avoid capital gains tax. Stocks in a Roth account have already grown tax-free, and there are no restrictions on charitable contributions being included on Schedule A (itemized deductions) just because the contribution was made from a Roth account.

There certainly are times when a taxable account makes a lot of sense for a client, but make sure it is been done for the right reasons and not because of misunderstandings on the potential benefits of a Roth.

What can you do about it?

Just like taxes have to be paid every year, taxes need to be part of your client’s education every year. This can be a combination of newsletters, videos, and client meetings, depending on how you currently share information. Most clients will only really pay attention to the information in a year that is relevant to them, but it can be hard to know what year that will be. These newsletters can be a great source of ideas for what to share; make sure you are picking areas that are relevant to your client base.

Happy Tax Planning!