Using Form 1040 to Identify Financial Planning Needs

Form 1040 is virtually unsurpassed as a road map to a client's financial needs, as well as a vital blueprint for developing financial planning goals. Without the information provided on this form, a financial planner would have to invest much more time and effort to identify a client's financial imperatives: for example, a young family's concern about college funding, a middle-aged couple's need for business capital or an older client's worries about having adequate retirement income and reducing the size of their estate. However, form 1040 is only a tool for identifying opportunities; considerable analysis usually is necessary before any recommendations can be made. This article describes how to use a client's form 1040 to identify financial planning needs and how to take advantage of an opportunity to complete a financial planning engagement for the client. MINING THE 1040 CHECKLIST A checklist such as the one on page 63 can help the planner pinpoint areas needing attention while prospecting for financial planning clients. Each category should elicit a series of questions to be raised with the client that might, in turn, reveal issues to be addressed in a financial planning engagement. Information as minor as a change of address can prompt financial planning concerns. If a client has moved since his or her last return was filed, there's a perfect opportunity to ask if property and casualty insurance, tax and estate planning issues have been addressed since the move. Residence in a new state may require new wills. The new residence also should be properly insured and withholding may need to be adjusted to reflect the deductions a larger mortgage may bring. After thoroughly reviewing the data on form 1040, the planner should schedule an initial conference with the client to assign priorities to specific financial planning goals. This can be done most effectively by reviewing line by line those form 1040 entries the planner has found to be of concern. Using graphics or computer-generated schedules should be avoided at this point. The objective is not to impress the client with financial wizardry but, rather, to develop a comprehensive personal financial plan in a series of segmented planning engagements.  What kinds of form 1040 entries should raise red flags? While some entries are obvious, such as excessive taxable investment income for a high-bracket taxpayer, others (inadequate diversification, for example) may not be as easy to spot. A few examples follow. High taxable income. The client's schedule B shows a large amount of taxable interest or dividend income. Is this income needed to cover family living expenses? Is the client in the top marginal tax bracket? Unnecessary taxable income may indicate a need to rearrange the client's investment portfolio. Investments that generate tax-exempt or tax-deferred income may be more appropriate. Investments also can be restructured to emphasize long-term growth if additional income is not needed to supplement wages. Consider the Smiths, a retired couple with a significant federal income tax liability. Their principal income source is interest on bank certificates of deposit (CDs) and oil and gas royalties. Itemized deductions on schedule A are minimal; they have no mortgage on their home and medical expenses are reimbursed by Medicare and private insurance. A conversation with the client reveals current income exceeds the amount needed for living expenses. Under these circumstances, asset reallocation could help the client diversify and reduce taxes. For example, transferring a part of the couple's assets to a single-premium deferred annuity will reduce the size of the estate subject to probate and the amount of income subject to current taxation; the couple will be able to make withdrawals from the annuity as needed and pay tax on that income only when they do so. …

Field of study: Business