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Most of my clients give me a copy of their tax returns when they file their taxes in April. However, many do not. My guess is that for those who don’t, it’s a simple oversight or they don’t understand why I need them or exactly what documents I am looking for. In some cases, they might not know how to get these sensitive documents to me in a safe way.
A few, I suppose, might see the sharing of their annual tax return as a privacy issue and more information than I really need. Tax returns reveal a lot about a person’s financial situation and some people might be reluctant to be so transparent about their personal finances. I get it.
Nevertheless, there are legitimate reasons why your financial advisor may request these documents.
Here are a few:
KYC. Known as the “Know Your Client Rule” or KYC, the Financial Industry Regulatory Authority (aka FINRA) requires financial professionals to “know the essential facts regarding every customer…” .
FINRA doesn’t specifically require that your advisor retain a copy of your 1040, but your tax return helps meet this requirement by providing key data regarding your income, sources of income, marital status, and dependents.
Detailed information. You pay your financial advisor to provide you with meaningful and accurate advice. Your tax return has the detailed information he or she needs to do that.
For example: A client might ask “Should I contribute to an IRA and, if so, what type?” I can’t answer that question without knowing more about your income and where it came from. Was all your income from Social Security, pensions, interest and dividends? Did you and your spouse earn more than the income limits for Roth IRAs? Did you participate in (or were you eligible to participate in) a qualified retirement plan at work?
Another example: Maybe you enjoy a lower tax bracket now than you might in the future. In this case, you could benefit from taking more out of tax-deferred retirement accounts like IRAs today rather than being forced to take out more in future years when your income and tax rate could be much higher.
Opportunities. Sometimes your tax return hints at ways to be a little more efficient with your money.
For example: A 1099, a Schedule C or income from an S-corp or LLC attached to your return would indicate that you have income from a side business or other form of self-employment. If so, you might qualify to do a larger tax-deductible contribution to a retirement account like a Simplified Employee Pension, Individual 401k or other retirement plan. Doing so could reduce your immediate tax bill and allow you to save more for retirement.
Another example: Your tax return would also show whether you itemize your taxes or take the standard deduction. If you own IRAs, are over age 70, and take the standard deduction, a Qualified Charitable Deduction or QCD might be a better way to give to your church or favorite charity. Your tax return would reveal this.
Problems. Your tax return can reveal mistakes and omissions to your advisor that can be addressed now rather than left for the IRS to discover later.
For example: You own an inherited IRA. A rather large one, in fact. Yet, your tax return shows nothing for IRA distributions. Required Minimum Distributions on inherited IRAs have become more complicated in recent years. In most, but not all, cases you must take an RMD every year. Failure to meet your RMD requirement can result in significant penalties. If your advisor notices a missed RMD he can suggest ways to address the issue before it gets worse.
Another example: You have been contributing money to IRAs above what the IRS allows. This is called an “excess contribution” and comes with a 6% penalty – for every year you fail to fix it. Make this mistake for a number of years and it adds up. A sharp advisor can point this out with a quick review of your return.
A good relationship with your financial advisor requires mutual trust. Providing him or her with a copy of your tax return gives your advisor the information they need to provide high quality advice, act in your best interests and serve you to the best of their ability.
If you haven’t done so already, talk to your advisor about the best way to receive this information and provide them with a copy of your tax return after you file it with the IRS.
To discuss any of the topics in this blog or to learn more about how we can help you Cross The Bridge To A Confident Retirement, please contact me through my web site mikebranch.net, call me directly at 651-379-3935 or email me at mpbranch@focusfinancial.com.