3 Tips to Realize a Better Net After-Tax Returnby
Whether your client wants to leave a legacy behind or plans to use their wealth to retire, taxes can have a big impact on the overall return.
Maximizing investments is a goal for every investor and if you want to help your clients realize a better net after-tax, these tips can help. Realizing better net after-tax returns is possible with the right strategic approach.
1. Review and Update Asset Location and Allocation
Clients want to save money on taxes, and it’s up to you to open up these conversations tactfully. Taking a household perspective provides an opportunity to save clients money. For example, the approach we recommend is:
- List all assets
- Number assets from least- to most-tax efficient
- Reallocate the least tax-efficient assets to tax-deferred and tax-exempt accounts
- Place the most tax-efficient assets into taxable accounts
Reallocating assets is a strategic process, and while sequencing withdrawals can save you money, a lot of unknowns exist, too. For example, predicting tax rates in the future is a guessing game, and if tax rates are lower in the future than expected, you might have taken a different asset allocation.
Once you have allocation in place, it’s time to consider strategies and vehicles to reduce the tax burden.
Note: Optimal asset location can help lower taxes, but it doesn’t replace allocation. A smart investment portfolio should have positions across multiple holdings to reduce risk during a market downturn.
2. Manage Tax Liability With the Right Strategies and Investment Vehicles
Selecting investment strategies can also help reduce tax liability. For example, Exchange Traded Funds (ETFs) are typically tax-advantageous over mutual funds. Why?
Well, there are a couple of reasons why. To start, mutual funds often incur more capital gains taxes due to the frequency of trading activity. Additionally, the capital gain tax on an ETF is delayed until the sale of the product, but mutual fund investors will pay capital gains taxes while holding shares.
Separately managed accounts (SMAs) and Unified managed accounts (UMAs) can offer even more tax benefits than an ETF. Let’s take a look at those now.
3. Leverage the Benefits of Separately and Unified Managed Accounts
SMAs and UMAs are two options for maximizing your clients’ tax advantages when investing. Each option has its own unique benefits:
1. SMAs are, for all intents and purposes, unbundled mutual funds. You invest in securities directly, and you can also leverage loss harvesting. Investors can offset taxable gains through portfolio losses, and this can significantly reduce a client’s tax burden in the process.
2. UMAs are uniformed accounts, and they place multiple investments into a single account, such as bonds, ADRs, commodities, individual stocks, ETFs, mutual funds or others. All of these assets go into one unified account.
UMAs can reduce tax burdens, but it’s crucial to consider the fees involved for management. Most UMAs require a standard fee of up to 1.0 - 1.5 percent annually for account management.
SMA vs. UMA
Opening a UMA requires in-depth conversations with clients to fully understand their investment goals and to fill the UMA with the proper assets.
SMAs have their place in portfolios. However, leveraging the tax benefits of SMAs is complicated and requires a complex process where investment decisions are made on the account level, requiring one to factor in each client’s acquisition date information and cost basis.
On the other hand, UMAs are holistic and allow for an advisor to manage the entire account with allocation adjustments. For advisors, UMAs also improve efficiency and scalability. For clients, UMAs can also be more convenient.
If you plan to offer UMAs to clients, it’s imperative that you:
- Learn the clients’ objectives before creating the UMA
- Invest based on various market scenarios
- Manage the account to adjust for volatility
Utilizing both SMAs and UMAs have their own advantages, and it’s up to you, as the advisor, to work with your client to determine what the best option is on a case-by-case basis.
Finally, if market downturns occur, they are rare opportunities to reposition a client’s assets into investments that are more tax-efficient. Use downturns to reevaluate tax strategies and make changes to a portfolio.
If you want to help clients realize a better net after-tax on their investments, it’s crucial to begin working on their portfolio today. The proper allocation and location of assets, types of assets, and vehicles used in the portfolio can help clients keep more money in their accounts after taxes.
Joseph Graziano, CFP® is the Vice President and Wealth Management Partner at FFP Wealth Management. Through FFP management, Joe and his team help manage over 2.4 billion in assets. FFP Wealth Management has served the unique needs of the accounting community for over 28 years and was formed out of dire need for accountants and financial...