The permanent federal income tax celebrated its 100^th birthday in the United States in 2013, a century after the ratification of the 16h Amendment to the U.S. Constitution.

The federal income tax is the largest source of revenue for the U.S. government. It is famous as one of the two unavoidables in life, along with death. That’s a rough affiliation.

So Americans pay their taxes, and many Americans complain about the tax rate they pay as they make their payments. The U.S. income tax is a progressive tax, so that those Americans with a higher income pay a higher percentage of that income to the federal government.

When those same Americans meet with their financial advisor to discuss investments, special attention is paid to those investments that will provide income at some future date, and much of the conversation surrounding tax matters revolve around the tax rate the investor will be paying at the time when the income is paid to the investor.

It is a matter of timing, and investors need to understand how income-producing investments relate to their tax bracket.

Meanwhile, new U.S. President Donald Trump is promising to convert the tax code to lower tax rates and make the process of filing taxes easier. When that day arrives, and the tax code has been converted, advisors and investors will be having numerous conversations about how the next tax code affects previous investment decisions.

Spectrem’s newest wealth segmentation series study asked wealthy investors how they feel about the tax bracket they are in and their overall attitude toward their tax burden. This information can provide advisors with a view of how their investors will approach investments that are tax-advantaged or defer tax payments to the future.

In Financial Behaviors and the Investor’s Mindset, Ultra High Net Worth investors with a net worth between $5 million and $25 million were asked first to state which tax bracket they are in based on their income level. The brackets go up to 39.6 percent (and in the report was stated as 40 percent), where 18 percent of UHNW Investors said their tax bracket is.

Twenty percent said their tax bracket was 35 percent, 20 percent said 33 percent, and 19 percent said 28 percent. That’s 77 percent of the UHNW investors with a stated tax bracket between 28-40 percent.

Those same investors were asked what they thought their tax bracket should be. Only 4 percent felt 40 percent was appropriate, and only 7 percent felt the same way about the 35-percnet tax bracket. Twelve percent felt 33 percent was appropriate, and 18 percent were willing to pay 28 percent. That equals 41 percent of the UHNW investors, showing a much lower preferred tax rate than the one those investor are actually paying.

Advisors are likely to deal with investors for whom taxes are a significant matter, and understanding the investor’s point of view about the taxes they pay is an important component of the relationship advisors have with their clients.

From the UHNW investors segment, which is obviously going to be a heavily taxed segment due to high levels of income, 58 percent believe they pay too much in taxes. Coincidently, 58 percent agree that the wealthy should pay a greater portion of taxes.

Top Takeaways for Advisors

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A financial advisor is not the same as an accountant, and investors are likely to get much of their advice about taxes from their bookkeeper. However, most investments do include some sort of income or increase in value as the reason for investing, and investors do need to know how their tax bracket will come into play with each investment. Determining an investor’s understanding of how taxes affect their investments is a wise step in the early stages of a relationship, and whenever a major portfolio change takes place.  

A financial advisor is not the same as an accountant, and investors are likely to get much of their advice about taxes from their bookkeeper. However, most investments do include some sort of income or increase in value as the reason for investing, and investors do need to know how their tax bracket will come into play with each investment. Determining an investor’s understanding of how taxes affect their investments is a wise step in the early stages of a relationship, and whenever a major portfolio change takes place.  

 

©2017 Spectrem Group