"Tax diversification is just as important as investment diversification," said Marguerita Cheng, a certified financial planner in the Bethesda, Md., office of Minneapolis-based Ameriprise Financial Services Inc. She declined to disclose the value of assets she manages.
Ms. Cheng is suggesting that clients trim back on the $15,500 pretax maximum they currently can channel into 401(k) deferred-savings plans and instead, if eligible, put $5,000 into a Roth IRA.
"They may be giving up some of the tax benefits today, but later on when they need the money most in retirement it's going to be tax-free," she said.
Other advisers are preparing higher-income clients for possible conversion of their conventional individual retirement accounts to Roth IRAs. In 2010, individuals with income exceeding $100,000 will be eligible for Roth IRAs for the first time.
"I've never been a big Roth advocate," said Mark Brown, a CFP and managing partner with Denver-based Brown & Tedstrom Inc., which manages $350 million in assets. "I would rather forestall paying taxes at all costs before I would volunteer paying taxes on my retirement fund."
In the current environment, however, "paying tax on a beaten-down account" may be attractive, Mr. Brown admitted, as long as the investor has money outside the qualified retirement account to pay the taxes.
"Instead of a $1 million account, a client may have a $600,000 account right now but eventually, it will become a $1 million account again," he said.
In addition to Roth IRAs, advisers also view municipal bonds and dividend-paying stocks as tax-saving investments.
Ms. Cheng, for example, is recommending that investors build a three- to six-month cash reserve and then put excess funds into tax-free municipal bonds or muni-bond funds.
RARE OPPORTUNITY
"There are currently terrific yields on muni bonds," said Austin Frye, a CFP with Frye Financial Center in Aventura, Fla., which manages $150 million in assets.
"If President-elect Obama raises taxes as promised," tax-free municipal bonds will become even more attractive, he said. "We're buying munis now in anticipation of that; they've been crushed by the stock market crash and the bond crash."
According to Mr. Frye, the current market presents a rare buying opportunity.
"This is a once-in-a-hundred-year event, where people have been selling everything good stocks, bad stocks, and bonds, too," he said. Indeed, as muni prices have fallen, their yields have risen to a record 173% of the yield on 30-year Treasury bonds, up from the 94% average last year, according to Municipal Market Advisors, a research firm based in Concord, Mass.
"The closer you are to retirement, the more you want to go into municipals," Mr. Frye said. Those in their late 30s to 60s should have anywhere from 20% to 50% of their assets in muni bonds, he said.
"Some muni bonds and some investment-grade closed-end mutual funds which have pre-tax yields of 10% are incredible buys right now," Mr. Brown said.
Dividend-paying stocks are another tax-friendly option. Stocks with safe dividends are attractive because qualified dividends are taxed at 15% rather than at ordinary income tax rates, which start at 29%. However, Ms. Cheng cautions investors to avoid volatile, high-yielding stocks where the dividend and the company's financial health may be uncertain.
"I would not make a decision based on yield alone," she said. "I would go for quality, brand and consistency."
"There is a place for security in dividends," Mr. Frye said. However, he cautions against moving too many assets into dividend plays, because he believes that the biggest gains will come from growth stocks as the country emerges from its current economic turmoil.
"Taxes matter," Mr. Brown said, "so we are definitely taking that into consideration in planning now and in 2009."
Still, he does not recommend making taxes the prime investment consideration. For example, doing a 1031 exchange in connection with the sale of real estate in order to avoid a 15% capital gains tax can be a mistake if the deal makes no economic sense, Mr. Brown said.
"Investors may pay 30% to 50% more for a property to save 15% in capital gains taxes," he said.
"I don't believe in letting the tax tail wag the dog," said Kim Dignum, a CFP in the Fort Worth, Texas, office of Raymond James Financial Services Inc. of St. Petersburg, Fla. However, she does favor investing in municipal bonds for clients in high tax brackets. In general, high-income clients within 10 years of retirement should move more of their assets into fixed-income instruments, said Ms. Dignum, who manages about $200 million in assets.
In this economic environment, she favors large-cap stocks that are cash-rich, have little debt and pay a dividend. "I'm not letting the dividend [size] make the decision," Ms. Dignum said. "The company and its financial strength are."
E-mail Janet Morrissey at jmorrissey@investmentnews.com.
