The tax return closerArticle added by Brian Gilder on August 7, 2009

Brian Gilder


Joined: August 21, 2010

Note: To view the tax forms referenced in this article please click here.

I was recently referred a couple --aged 57 and 60 years -- who wanted to retire this year. Their current financial advisor recommended an investment of $265,000 into an annuity, but the couple wanted a second opinion about the recommendation.

When I talked to the couple on the telephone, I asked them to bring certain items to the meeting, such as a copy of their tax return and a list of questions. The very first question I was asked, "Was this annuity a good investment?" I replied that, until I had a better understanding of their goals, objectives and risk tolerance, I wouldn't know.

The couple provided me with a 25-page financial planning report from their financial advisor, along with a five-page sheet that their advisor had asked them to fill out. The couple did not understand anything in the report and, quite frankly, the only interesting items in this report were the color graphs. While some advisors prepare reports, charts, and have the client fill out forms, I read the tax return. The tax return tells you approximately 90 percent to 95 percent of the information you need to know about the client.

So, let's look at exhibit no. 1 on the tax return. Wages (form 1040, line 7) are $230,000.

Question to clients: "I see your wages for the year were $230,000; do you have a retirement plan at work? If so, do you still contribute to the plan?"

Client's response: "Yes, we have a retirement plan and we contribute 6 percent of salary."

My response to these clients was, "Before you retire from the company, we should talk with your human resource department. I want to make sure all your benefits are coordinated correctly, such as 401k plan (rollover), and life insurance benefits."

Next, let's look at form 1040 (exhibit 1) line 8a. Taxable interest is $319. Now, if you look at Schedule B, (exhibit 2) part I, ABC bank $174 and XYZ bank $145, which totals $319.

Question to clients: "How much interest do you earn in ABC and XYZ bank?"

Clients response: "Both are six-month CDs that earn about 3 percent interest."

Therefore, I know the clients have approximately $10,000 in cash ($319/.03).

Question to clients: "How much are your monthly expenses?"

Clients response: "$5,000-$6,000 a month."

Therefore, I know the clients have approximately two months of an emergency fund available in case they lose their job or any unforeseen expenses occur. I would tell the clients, that they should at least six to nine months of liquid cash. "Mr. and Mrs. Client, you only have two months of liquid cash. Therefore, as part of our financial plan, we will need to increase your cash."

Question to clients: "Any credit card debt?"

Client response: "$12,000 in credit card debt at a rate of 14 percent interest rate."

I wonder if the advisor recommending the $265,000 annuity ever asked about credit card debt...

Let's look at Schedule D, (exhibit 3). This is where most sales of stocks, bonds, or mutual funds are reported. If you look at part I of the schedule D, XYZ managed account, the client bought XYZ managed money account on Aug. 4, 2008 and sold the investment on Dec. 31, 2008 for a sales price of $265,474. The clients paid $413,124 for the investments and have a short term loss ($147,650).

Question to clients: "You owned XYZ managed money account for only five months. What was the reason for selling?"

Client's response: "We are scared of the stock market and can't handle the volatility."

Therefore, the annuity recommendation by the other advisor could be a sound investment for the clients. Also, the Schedule D would lead to 10-15 sales ideas and issues about the clients."

In reviewing just a couple of items on the tax return, we now know the following:
    1. The couple is 57 and 60 years old and they want to retire.
    2. The couple has retirement plans at work.
    3. They're scared of the stock market.
    4. They lost $147,650 in the stock market in five months.
    5. They do not like volatility.
    6. They only have two month of liquid cash.
    7. They have $12,000 in credit card debt at a rate of 14 percent.
    8. Their monthly expenses are $5,000-$6,000 a month.
The big question is: Should they invest $265,000 into this annuity? No. This is where agents become greedy financial "sales" people. Let me show you why. Look back at Schedule D. If you look at the sales price of $265,474, the advisor is investing all the client's money into this annuity, without taking into consideration any of the following issues:
    1. What about the clients cash position of only $10,000? The client's need another $20,000-$30,000 liquid to cover their $5,000-$6,000 monthly expenses.

    2. How about the $12,000 credit card debt at 14 percent interest? How about telling the client to pay off the credit card debt.

    3. Does the client even know what type of annuity the advisor recommended?
Do you think the advisor asked them about their cash position or credit card debt? The financial "sales" person would sell them the $265,000 annuity; the true financial advisor would use a portion of the $265,000 to fund the annuity.

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