“Tax complexity itself is a kind of tax.”
– Max Baucus
Failure to consider tax management as a component of wealth planning can impact long-term results and limit spending power in retirement. In fact, for many investors, taxes remain the largest source of portfolio management inefficiency and cause of mediocre investment returns.(1) That’s where a wealth planning professional comes in.
The wealth planning professional can help clients transition assets appropriately, update legacy positions, and better time transactions. By working with a tax advisor, when appropriate, a wealth planning expert can also potentially help clients minimize taxes owed. In so doing, they add what is called “tax alpha” to returns (tax alpha is any strategy to reduce the amount of tax drag on a portfolio, which in turn has the potential to increase the ultimate ending value of the portfolio).
At Magellan Financial, we aim to generate tax alpha by leveraging three specific strategies: tax transition techniques, capital gains management, and asset location optimization. If you want to learn more about how each has the potential to positively impact your investment plan, this article is for you.
Tax Transition Techniques
The tax implications of a portfolio transition to a new advisor can often be a cause for concern. Switching firms almost always results in changes to investment holdings, even in the case of a like-for-like position swap. Especially in volatile markets with rapidly moving valuations, such changes can prompt taxes owed on any capital gains generated to date. Some costs may be unavoidable, but others aren’t. An advisor can take proactive steps to attempt to mitigate or even eliminate the costs associated with asset moves.
When evaluating a taxable investment account, Magellan Financial looks at every position and asks if we would buy, hold, or sell. If capital gains would result, we discuss our reasoning with the client. Sometimes it’s in a client’s best interest to sell over time, depending on the amount of capital gains. In any event, we develop a gameplan for managing the transition to the portfolio we want to achieve. We also use more tax-friendly investments in taxable accounts to best minimize taxes moving forward, as well as offering the ability to time when short-term & long-term gains are taken.
Capital Gains Management
Tax loss harvesting in non-qualified accounts (i.e. not IRAs, ROTHs or 401k) is also an important part of managing taxable investment gains. The practice can help offset realized gains to minimize taxes. If a client wants to realize a loss but maintain exposure to a particular asset class that can also be achieved. For example, there are often multiple ETFs that provide comparable sector exposure. Similarly, an investor can usually sell a loss on an individual stock while also purchasing that stock sector’s ETF or elect to repurchase the position after 31 days to avoid wash sale rules.
Another area where we help clients is by developing a plan to make donations in long-term appreciated stock instead of cash. This can help you both support those organizations that share your ideals while simultaneously minimizing taxes. Investors can also make charitable contributions from an IRA if they meet certain criteria. Those age 70 ½ or older can contribute up to $100,000 from their IRA directly to a charity, and in so doing avoid paying income taxes on the distribution. This is known as a qualified charitable distribution. It is limited to IRAs, and there are also other exclusions and considerations.
Finally, consider giving family members appreciated stock instead of cash. For 2022, the 0% capital gains taxable income threshold is up to $41,675 for individuals and $83,350 for married couples filing jointly.(2) Depending on your tax situation and that of the recipient(s), you can often give shares to them which they can proceed to sell at a reduced tax rate compared to you selling the shares. Individuals are allowed to go over the annual gift limits, would require to report gift and possibly utilize lifetime exclusion amounts.
Optimization of Asset Locations
Our investment management goals for clients include attempting to postpone the realization of taxable gains while maximizing realized losses. That strategy means that we assign assets to places in the portfolio that aim to optimize after-tax returns. While quantifying the benefits of tax-aware planning can be difficult and varies from person-to-person, recent research suggests that location management techniques can add 50 to 75 basis points of value to investments.(3)
Any asset location strategy should address three overlapping aims:
- Taxable portions of the portfolio should reduce or postpone taxes on gains (especially short-term gains) whenever possible
- Investors should rely on tax advantaged (retirement) accounts for their less tax-efficient investments
- Wealth professionals should use tax-aware practices to maximize after-tax performance while minimizing pre-tax impact on client returns
Communication and cooperation among tax, estate, and investment professionals on your team can support a better outcome for your overall investment performance, over time. As we laid out in our recent blog, an effective group of advisors that collaborate on your behalf can brainstorm ideas and paint a more holistic financial picture. Working together, they can usually develop the most tax-efficient and most effective strategies for achieving your financial goals.
How To Get Started With Tax Efficient Strategies
Through a tailored tax management plan, Magellan Financial can help clients improve cash flow, reduce investment risk, and increase portfolio value. We also integrate required minimum distributions into the wealth planning process to optimize current and future tax implications. We seek to protect your investment returns and integrate withdrawal schedules so that taxes don’t absorb more of your hard-earned wealth than necessary. Most importantly, we aim to ensure that your tax strategy aligns with your larger financial goals.
For More Information About Our Tax Efficient Strategies For Wealth Management, Contact Our Team Of Financial Advisors Today!
Wells Fargo Advisors Financial Network and its financial advisors provide non-fiduciary services only. They do not provide investment advice [as defined under the Employee Retirement Income Security Act of 1974 as amended (“ERISA”), have any discretionary authority with respect to the plan, make any investment or other decisions on behalf of the plan, or otherwise take any action that would make them fiduciaries to the plan under “ERISA”.
Wells Fargo Advisors Financial Network and its affiliates do not provide legal or tax advice. Transactions requiring tax consideration should be reviewed carefully with your accountant or tax advisor. Any estate plan should be reviewed by an attorney who specializes in estate planning and is licensed to practice law in your state.