Ric Edelman: This has been one of the worst years for the financial markets in several decades. However, there is a narrow window for advisors to help their clients lower their taxes thanks to the lousy market we’ve had this year. Michael, 2022 is the ultimate year for tax management. What do advisors need to know?
Michael Lane: This is an unprecedented year. You have to go back almost 50 years to have an opportunity like this to harvest losses and establish an opportunity for you to use those losses going forward for the next five or ten years. That’s because capital losses that exceed capital gains in a year may be used to offset ordinary taxable income up to $3,000 in any one tax year. And net capital losses in excess of $3,000 can be carried forward indefinitely until the amount is exhausted.
Ric: People tend to focus on their returns. They tend to look at how much money are they making in their account. What people tend to forget is it’s not what you earn that matters, it’s what you keep.
Michael: That’s right. Most people focus on the total return and they focus on cost. People will sell things to save one basis point or two basis points. Say you had a fund that was worth $100,000 and it was going to distribute, say, a 5% capital gain this year. Even though you lost money it is still going to distribute a 5% capital gain. If you just look at a typical person that’s paying normal capital gains tax rates, that actually costs you $1500, which is 15 basis points (and compounds). That’s 15 times what a lot of people will look at as the primary focus when they’re building their portfolios and just looking at the cost of it.
Ric: So I think this is what confounds a lot of people, Michael, is that they don’t understand how in a year like this, with the stock and bond markets down, how can there be capital gain distributions in their funds? How can they have gains in the middle of a year of losses?
Michael: At the beginning of the year, you could be down 25 or 30% this year and then get a tax bill for thousands of dollars to pay taxes on the distribution from that mutual fund. That’s because the portfolio manager probably had to sell certain securities in the fund that he or she may have held for many, many years. Now they distribute the capital gains to you. And even if you have a loss, you could get a tax bill. So you need to manage your tax concerns before the end of the year.
Ric: What work should advisors be doing now to help mitigate the tax bite of capital gains?
Michael: As we approach the end of the year, the term “record date” is going to become critically important because that’s the date that you may want to sell out of a specific fund and reinvest into something that’s more tax efficient to avoid that distribution. That way, you could take the loss.
Ric: And so you mentioned record date. Let’s explain what that is for folks, because as you said, it is an important date. So define that for us.
Michael: There are record dates and there are “X dates”, and it can be confusing. Simply, if you own shares in fund on its record date, that means you’re going to get the distribution. The record date is like the last day that people can sell before and not receive the distribution. If you hold it past that record date, you’re going to receive the distribution. There’s also an X date. If you buy it after the X date, you won’t get the distribution. So it’s a very important to make sure that you sell before the record date, and you buy after the date. Otherwise, you could literally buy it right before X date, have no return, and then have a tax bill.
Ric: Talk about how financial advisors are partnering with BlackRock to help their clients save money on taxes in a year like this.
Michael: When we’re talking about these dates, it’s almost like a shot clock, you know, at a basketball game or game clock in a football game where it’s ticking down. Advisors need to pay attention to that shot clock. How many days left do I have before I have to make a move in order to potentially help my clients save on taxes?
Using the BlackRock Tax Evaluator tool, a financial advisor can enter client portfolio information into the tool. Then the tool tracks the record dates and shows you how much time you have before you need to make a transaction to avoid the capital gain distribution for mutual funds, ETFs, and even some international ETFs in that client’s portfolio.
Ric: Was this tool built with financial advisors in mind?
Michael: Yes. Our responsibility to the financial advisor community is to provide tools like the tax evaluator tool along with the correlation calculator, which is a tool that will help advisors understand what types of alternative investments somebody could move into if they were going to take a tax loss from some investment. You want to be careful not to have a wash sale where you buy something that’s basically very similar or exact to what you just sold because then you’ll lose that tax.
Ric: I’ve looked at BlackRock’s tax evaluator tool and see how it could help advisors determine where a client stands, what could happen if they take no action and what moves could reduce their tax liability. Thanks again Michael.
Michael: Thank you, Ric. I enjoyed our conversation.