Category Archives: Taxes

Why Congressionally-mandated FIFO accounting will adversely impact your clients – and what you can do about it.

This past Saturday morning, the Senate passed their version of the Tax Cuts and Jobs Act bill. One of the lesser known provisions in the Senate bill, was the elimination of an investor’s choice to identify which shares of securities they may wish to sell or donate. The provision states that the only way securities may be disposed of is through use of an accounting method commonly referred to as First-in First-Out (FIFO) where the oldest shares purchased are the first ones an investor may sell. Because of the protracted appreciation of the securities market, the first shares purchased are likely to be the lowest cost and therefore carry the most gain (and resulting tax penalty).

The House version did not include this particular provision. And because there exists so many differences between both versions of the bills, this past Monday, Congressional Republicans went to a Conference Committee to begin reconciliation efforts on the various differences between the two tax bills. Led by House Ways and Means Committee Chairman Kevin Brady, and Senate Finance Committee Chairman Orrin Hatch, there are a number of hot topics that will need to be negotiated – including individual tax rates, the handling of AMT, child tax credits, corporate tax rates and repeals to the Affordable Care Act.

Because of the number of big-ticket and high visibility items included in the bill coupled with the pace the legislation is advancing, some experts fear that the FIFO provision may be overlooked and ultimately absorbed into the reconciled bill as collateral damage to bigger-picture negotiations.

However, we at Adhesion believe that this would be shortsighted as the provision is damaging to the very investors and savers that it is purports to protect. The provision has virtually no impact on the $1.7 trillion funding gap the bill creates as it is currently scored at generating just $2.4 billion over 10 years. As inconsequential as those revenues may sound they don’t even consider the expense side of the equation – no official estimates exist thus far on the offsetting expense associated with infrastructure retrofit needed to operate, report, comply and monitor the changes thrust upon the industry. And it certainly does not consider expenses associated with policing and adjudication of these matters.

Interestingly, the Investment Company Institute, the powerful lobby representing the mutual funds and ETF industry, were granted an 11th hour carve-out reprieve in the Senate bill to allow mutual funds and ETFs to continue to sell specific tax lots within their pooled investment vehicles. It is important to note this carve-out exemption for institutional investors does not extend to those retail investors purchasing and selling these instruments, only how the fund itself accounts for the gains and losses within their portfolios.

We feel there are some other anti-competitive and unwarranted elements in this provision that members of Congress, investment advisors and end-investors should be gravely concerned about. Specifically –

  • When the Senate proposed a carve-out provision that protected the institutional fund companies and ETF providers while ignoring the retail investor class, they created an uneven playing field that is heavily tilted against retail investors. Through this provision, the institutional investor will be afforded a significant advantage as they may exit any tax lot they wish. With the freedom to select tax lots, the institutional investors can sell at will, whereas the retail consumer will be locked-up due to tax costs associated with their low-basis FIFO shares. This sort of unfair playing field is analogous to suggesting institutional investors can trade commission-free yet retail investors must always pay commission. The provision creates an enormously unfair and artificial trading barrier that will heavily disadvantage retail investors.
  • With this barrier in place, end-investors will likely open up different brokerage accounts or have paper certificates issued to them. In both cases, there is no reasonable method to enforce or monitor for this type of behavior. This will drive up operational costs for advisors and custodians which will ultimately be passed through to the end investors. And by exploiting this loophole, the revenue projections for this provision are likely to fall even shorter than expected.
  • By adding friction to the retail investor’s ability to liquidate securities through a FIFO provision, one should assume that there will be less selling – which leads to less liquidity and efficiency in our capital markets. This also means that retail investors will be less inclined to eliminate assets in an attempt to seek diversification. This will ultimately lead to concentrated and highly appreciated holdings in client portfolios which runs in stark contrast to tried and true investment principles of diversification, rebalancing and buy-low/sell high for retail investors. This introduces the potential of an enormous loss during a market correction as well as introducing excessive levels of portfolio risk – all while stifling the efficiency of the capital markets.
  • This provision disproportionally burdens older investors who likely have a more extensive tax history and on average maintain a lower cost basis than younger investors. This FIFO tax also represents an unplanned expense that retirees had not budgeted for – which will erode retirement savings at a time when retirees have very little time to recoup this new, unanticipated retirement gap.
  • This provision also disproportionally disadvantages middle- and upper-income investors who are more likely to hold FIFO-eligible securities. Contrast that with ultra-high net worth and institutional investors who frequently hold real estate, hedge funds and other sheltered ‘accredited investor’ assets, which can be exempted from FIFO provisions as a result of the Senate’s proposed carve-out clauses.
  • Lastly, if legislation is advanced, one unintended consequence facing mutual funds and ETF providers is that retail investors will likely seek to avoid concentrated positions so as to have more choice on which shares to dispose of. Mutual funds and ETFs are pooled investment vehicles, and as such, they are generally far more concentrated in a client portfolio than individual equities. We believe advisors and investors will wisely consider diversifying out of concentrated mutual fund and ETF holdings into a larger basket of diversified equities so as to have multiple tax lots to sell. So rather than purchase Coke multiple times, an investor may consider purchasing Coke, Pepsi, Dr. Pepsi and Constellation Brands. Security prices and equity valuations may no longer be dictated based on rational, sound fundamentals, but rather from a desire to exploit loopholes in heavy-handed government legislation.

For a bill that is intended to promote simplification and fairness, we think it does just the opposite. It unfairly penalizes the retail investor with a FIFO tax while introducing liquidity friction and complicated recordkeeping. At the same time, it rewards the large institutional and ultra-high net worth investors with flexibility to use their own preferred inventory accounting methods. Most would argue that if framed properly and viewed in its totality it would be difficult to defend.

So what can you do? We think this particular provision just needs a bit of sunlight so that it can be evaluated and debated in the open. With enough voices we think we can make this happen and we encourage you to get involved.

First off, encourage your clients to take action.  Consider directing them to TD Ameritrade’s Legislative Action Committee site, which has done a fantastic job of highlighting the issue.  From this site, they may contact their local representatives .

Next, as investment fiduciaries we would urge you to read the Money Management Institute’s position on the Senate version of the tax reform legislation.  On their site, the MMI chairman, Craig Pfeiffer shares talking points and a number of template letters you can use to contact your elected officials.  Similarly, the Investment Advisor Institute – an advocacy group for SEC-registered investment advisory firms has developed a site to contact elected officials and communicate your concerns of FIFO legislation.  Adhesion has also drafted an open letter to Congress which can be found here.  Feel free to use it or modify it and share it with your elected officials.

Also, as we head into year end, consider generating losses through active tax harvesting.  These losses can be used to unwind concentrated mutual fund or ETF holdings or buffer against future taxable gains resulting from potential inflexibility associated with this bill.  For more information on the value of tax harvesting and how it can add value to a client portfolio, feel free to watch this webinar

Lastly, we think now is a good time to dump concentrated mutual fund and ETF holdings to spread those proceeds into a diversified pool of equity holdings.  If you are interested in active equity managers, please consider Adhesion’s Asset Manager eXchange which can be found here.

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Embracing Flexibility

Today’s Unified Managed Account (UMA) offers the masses an affordable mechanism for achieving portfolio diversification with management expertise – formerly achievable only with mutual funds – with the flexibility, control, and tax efficiency traditionally associated with SMAs.

CNBC has a new article on its site, and it does a good job highlighting key benefits of managed accounts. These are the same benefits sought by the advisors we speak with every day, including:

  1. Personalization
  2. Transparency
  3. Tax-efficiency

With today’s UMA, managed accounts are available to the masses, no longer simply an elite product for wealthy individuals and institutions. Leveraging Adhesion’s UMA platform, advisors deliver sophisticated investment services across all segments of the client base with the following benefits:

  1. Hefty account minimums are no longer an obstacle
  2. Expensive and tax-inefficient mutual funds are no longer the only vehicle for employing professional managers
  3. Low-cost, passive products are easily blended with active and/or tactical management in a single account
  4. Client-specific customizations or restrictions can now be efficiently accomodated

By partnering with Adhesion, RIA firms can not only shed back-office functions but actually win new business through differentiated investment delivery. We invite you to learn more about how the right UMA provider can help you grow a more sustainable practice.  To read the CNBC article in its entirety, click here.

 

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Capital Gains Opportunity to Add Tax Alpha

Many advisors are currently in the process of selling off stocks; some as a precautionary measure as major equity indexes reach record highs, and others to rebalance portfolios by trimming the fat. The catch is that, thanks to a six-year bull market, many clients hold appreciated stocks that trigger taxable gains when sold. The upside for advisors is that these unavoidable taxable events present great opportunities to show their clients tax alpha. Or, as Financial Planning puts it, “How can advisors sell stocks and avoid a painful tax bite?”

The traditional way to offset these taxes is to balance portfolio gains with losses. However, many losses leftover from the 2008-2009 crash have been used up. Financial Planning offers advisors several approaches for adding tax alpha through offsetting clients’ capital gains. For one thing, advisors can utilize technology to optimize rebalancing processes. Says Lance Gunkel, COO at Sherpa Investment Management in West Des Moines: “We utilize a rebalancing tool that uses algorithms to come up with the most tax-efficient way to rebalance or get out of positions. In the current environment, this may mean taking offsetting losses in other asset classes, such as emerging markets debt and international equity.” Advisors seeking losses should also take a look at energy stocks due to plunging oil prices.

Advisors should also counsel clients to consider charitable contributions. As long as a share has been held longer than one year, the donor can get a tax deduction for its full market value. This way, clients can hold onto the cash they might otherwise have donated with the added benefit of offsetting capital gains.

Sue Stevens, an advisor out of Deerfield, Ill, suggests approaching retirement distributions as a way to minimize taxes. Says Stevens: “One tactic I’ve been using lately is doing 15-year tax projections for clients in early retirement. There may be opportunities to take IRA distributions or do Roth conversions in years when taxable income is low. They can also recognize significant capital gains.” Gain harvesting is another way to minimize tax hits; it’s especially effective for investors with more modest incomes. With this strategy someone can sell an appreciated security and realize the gain without incurring any additional tax.

Advisors looking for continued growth and new ways to stand out from the competition should be evaluating how they can assist clients with tax issues. Adhesion is in the business of powering advisor alpha, so we already have powerful solutions in place to help you add tax alpha. Check out this short video to learn more.

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Advisors: Embrace the Client’s 1040

There’s no question that taxes and tax policy are front of mind for many of your clients – many have just experienced their highest capital gains distributions in years. This is a prime time to demonstrate your value to clients by adding after tax value to their investments.

Many advisors are hesitant to discuss a client’s tax return. Get over it! At this point you might be asking yourself: doesn’t my client already have a CPA? While this is likely the case, as ThinkAdvisor points out you as the financial advisor may have the stronger value proposition that appeals to the higher- net worth client. At the very least you can play the role of quarterback and coordinate the team of advisors assisting your client; provided you can identify the appropriate tax benefits and problems.

According to this ThinkAdvisor article, a great way to do it is by reviewing your clients’ tax returns and suggesting changes. Here are some of the relevant tax issues that ThinkAdvisor recommends going over with your clients.

Line 8a: Taxable Interest

If the client has a large amount of taxable interest and/or is in a high tax bracket, consider replacing some of their taxable investments with tax-exempt vehicles.

Line 9b: Qualified Dividends

Remember that ordinary dividends are taxed as ordinary income, while qualified dividends are taxed at your client’s capital gains rate (20%, 15% or 0%).

Line 13: Capital Gains

If your client has a substantial amount of capital gains and/or any capital loss carryforwards, they may be able to use the losses to offset their capital gains for the current year. If there are no capital gains, or there are capital loss carryforwards remaining after eliminating all capital gains for the year, up to $3,000 of the carryforward can be used to offset ordinary income.

Line 15: IRA Distributions (and other retirement plans)

Line 15a includes the portion of the IRA distribution that is not subject to income tax. Line 15b is the portion that is taxable. If the distribution as a percentage of the total IRA is too high, it could cause your client to prematurely exhaust their IRA. You might want to advise them to consider a Roth conversion; especially if they don’t have to have the income.

Line 20: Social Security Benefits

Line 20a contains the total amount of Social Security received. Line 20b is the amount that is subject to income tax. The amount that is taxable is determined by the taxpayer’s filing status and modified adjusted gross income (MAGI).

Tax Alpha isn’t just about income tax returns. Enter the Adhesion Advantage. The Adhesion Advantage lets high-performing advisory firms save time and resources by automating key tax aware strategies. The tax-aware investing process becomes a lot more efficient when incorporated with Adhesion’s technology and overlay managers. The Adhesion Advantage significantly augments advisors’ ability to add tax alpha and show clients real value.

Check out this short video to learn more.

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Knowing the Tax Consequences Can Grow Your AUM

According to the Wall Street Journal, “financial advisors are going back to tax school.” This trend is due in part to the fact that tax issues are becoming both increasingly complex and more critical than ever to financial planning. Additionally, recent tax code changes have created new challenges for clients and advisors; particularly in regards to taxes on investment gains. The WSJ points out that, in contrast to the traditional approach of helping clients minimize exposure to estate taxes, the focus has now shifted to minimizing taxes on long-term capital gains. Says Daniel Johnson of Parsec Financial in the article: “Taxes are such a complex matter now and it seems like every year or two there’s a change that affects a large portion of our client base.”

Otherwise competent advisors may not be as tax-aware in their portfolio management as they could be. Even a relatively high-performing portfolio may be exposing a client to unnecessary tax liability. For instance, an April 6th article in the WSJ describes a case where a business executive with a $500,000 taxable investment portfolio approached financial advisor Anthony LoCascio for a second opinion. The issue wasn’t performance; under the management of her current advisor the portfolio generated $48,000 a year in capital gains and income. Her concern stemmed from the fact that, on top of capital gains taxes, she was paying a 3.8% Medicare surtax and $4500 annually in advisor fees. Mr. LoCascio felt that she could be doing better in terms of taxes and fees and still see comparable returns. He explained:

“Why pay taxes on money you’re not using? The strategy wasn’t appropriate for this client based on her tax liability.”

His solution was that the woman move $300,000 into a portfolio consisting mostly of tax-managed ETFs. These ETFs have lower fees than most mutual funds, and use strategies like tax-harvesting to offset taxable distributions. The remaining $200,000 was placed in a deferred annuity with no management fees. This way she would see no taxes on growth until she pulled it out for retirement. The executive ultimately chose to move her money over to LoCascio’s firm. The result was that her management fees dropped to $1500 a year thanks to the no-fee annuity, while the dual strategy of ETFS and deferred annuity eliminated her short-term taxable investment income. She also continued to see the same kinds of returns as she did before the switch. Says LoCascio:

“Advisors should really take a look at how taxes affect everything. Some advisors don’t have a choice about what they charge, but they can make a difference when they understand the effect of things such as the 3.8% surtax and what that means to their clients.”

Adhesion can help advisors more cost effectively add tax aware investment strategies to their business. Check out this short video for more information.

However, it can be difficult for advisors to implement an overall tax-efficient strategy when a client’s family has assets, like annuities, outside of their custodial account. The answer is Unified Managed Household reporting. UMH reporting aggregates client financial data from many sources. It is designed to service households that may have multiple accounts and/or multiple custodians. This ability to consolidate the management of an entire household across multiple accounts means that an advisor can tax-efficiently allocate assets between taxable and tax-deferred accounts. Adhesion incorporates UMH reporting into its own solution so that advisors and clients can see and report on all of a family’s assets; even those that are held away from the custodian. This is one of the ways that Adhesion helps advisors become more tax-aware and add more Tax Alpha.

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Tax Season is the Perfect Time to Add Tax Alpha

As we near the April 15th deadline for filing, taxes are at front of mind for many advisors and their clients. It’s the time when advisors can significantly add to their value proposition by generating tax alpha for clients. According to a recent InvestmentNews article, though they may not play a direct role in preparing taxes, advisors can “mine the 1040 for additional information and savings ideas and provide an additional service to clients.” Meaning, investigating a client’s 1040 form can yield significant ways to add tax alpha this spring. In many ways, this is a more concrete way to demonstrate value to clients than promising a percentage of investment returns.

Here are some of the 1040 opportunities discussed in the article. First, advisors should be taking a close look at line items. A high amount of interest in line 8a is an opportunity for advisors to reduce that number in the future by reassessing their client’s investments. Another issue here is asset location. Tax efficient assets like municipal bonds might be better suited for a standard brokerage account or non-qualified account. Meanwhile, tax inefficient assets like emerging market debt may be better off in tax deferred account like an IRA.

For lines 9a and 9b, advisors should be asking where these dividends are coming from and their tax implications. However, the article cautions against focusing solely on whether dividends do or do not qualify to be taxed at the short-term or long-term capital gains rates. Stephen J. Bigge of Keebler & Associates states: “You have to look at the after-tax effect. Many clients complain that their advisor is generating all these short-term capital gains. You’re still getting a great return, and you’re still out ahead after taxes.”

When it comes to charitable giving, clients should know that there is a smarter way to do it than just giving cash. Donating appreciated stock can soften the blow of capital gains. The income tax reduction from charitable giving is reported on line 40. 1040 time is also an important opportunity to remind clients that now is a good time to fund a last-minute IRA contribution. Even if a client won’t qualify for a deduction for IRA contributions, they should still not miss out on the tax deferred growth offered by an IRA.

Another important component of adding tax alpha is building strategic alliances with CPAs and other tax preparers. This way, advisors get to focus even more on what they do best: working directly with the client. After all, an automated and outsourced solution is not just about delivering more in-depth service and consistency. It also keeps valuable resources free for client development.

However you do it, advisors should not be missing out on ways to add tax alpha to the value they show their clients. But one thing is for sure- in today’s environment, it’s not just about finding and implementing value-add strategies like tax alpha—firms have to be able to do it efficiently without compromising resources and face time with clients.

This is where Adhesion comes in. The Adhesion Advantage lets high-performing advisory firms save time and resources by automating key tax aware strategies. The tax-aware investing process becomes a lot more efficient when incorporated with Adhesion’s technology and overlay managers. The Adhesion Advantage significantly augments advisors’ ability to add tax alpha and show clients real value. But it’s important to keep in mind that adding tax alpha doesn’t have to create additional expense or burden your business with added complexity. Top advisors know this and are already realizing the benefits of outsourcing.

Check out this short video for more information.

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How to Give a Portfolio a Tax Alpha Makeover

As Allan Roth points out in a great article in Financial Planning (“Tax Alpha: How to Fix a Client Portfolio”), when an advisor takes over a portfolio for a new client there is an immediate opportunity to show value. Says Roth: “Good financial planners can be worth their weight in gold in helping clients build a tax-efficient portfolio.” Generating tax alpha right off the bat is a key way advisors can prove their value to clients. And for the most affluent clients, “achieving tax alpha can yield a small fortune annually.” According to Roth, giving a new portfolio a tax alpha-oriented makeover is a three step process: taking over the new portfolio and deciding what to sell, building the new portfolio, and helping the client with income recognition and withdrawal strategies.

Roth says that when he gets a new client he often finds himself wanting to sell off everything to build a new, more tax-efficient portfolio. However, the reality is that selling off everything at once would usually produce unacceptable tax consequences. This is due to the fact that recognizing large gains can have several unintended consequences, including these listed in the article:

  • Triggering high state taxes or the alternative minimum tax
  • Pushing a client into the 20% long-term capital gains tax rate (if income is more than $413,200 for single filers in 2015, or $464,850 for joint filers)
  • Prompting the 3.8% Medicare tax on passive income when total income tops $200,000 for single filers or $250,000 for joint filers
  • Phasing down the amount of allowable deductions

When it comes to selling, Roth recommends first determining where the marginal tax breakpoints are. In Roth’s words, “understand how much gain can be recognized before any of the triggers above would create more dire tax consequences.” This must be done initially, as the IRS doesn’t allow for do-overs. Next, advisors should go after the low-hanging fruit. This includes those current holdings that have tax losses or with minimal gains. Lastly, advisors must weigh the tax implications of a sale against the benefit to the client; the benefits being more appropriate asset allocation, lowering costs and more diversification.

The next step after selling off is to rebuild the portfolio while incorporating the legacy assets that weren’t sold off. Assets should be selected based on asset allocation targets agreed upon by the advisor and client. According to Roth, “The two critical components here are selecting tax-efficient products and locating the right products in the tax wrappers that maximize after-tax return.” Newly selected investments should be chosen for the long run so as to avoid turnover. This is because selling off any asset in a taxable account creates a gain or loss that has tax implications for the client. By holding onto assets with gains these taxes are deferred. Asset location is also important. Tax-efficient vehicles should go into taxable accounts, whereas tax-inefficient vehicles should be in tax-deferred account like 401(k)s and IRAs.

Finally, clients need to be getting counsel on how to manage their income. Mike Piper, CPA and author of Taxes Made Simple, offers some strategies on how to go about it. For instance, “income bunching” refers to when a client needs to recognize income to live on by taking funds from a qualified account, but faces a reduction or elimination of credits or cost-sharing subsidies the client would have otherwise received. By income bunching, the client can “take a larger taxable distribution every other year to balance the benefits of cost sharing and credits against the costs from being in a higher marginal tax rate.” Another strategy is “deduction bunching,” where the client’s deductions are bundled every other year. This way, a client can maximize the value of the deduction by alternating between using the standard deduction and itemizing. Tax-gain harvesting is another great way for a client to be able to recognize a gain without paying taxes.

These are just a few of the ways an advisor can reconstruct a portfolio to generate tax alpha. One thing is for sure: tax alpha is an (often under-utilized) way that advisors can immediately and significantly demonstrate real value to their clients. As Roth puts it, “Tax alpha may not be as much fun as portfolio construction — but it’s a clear way to help your clients immensely.”

In today’s environment it’s not just about finding and implementing value-add strategies like tax alpha—firms have to be able to do it efficiently without compromising resources and face time with clients. The Adhesion Advantage lets high-performing advisory firms save time and resources by automating key tax aware strategies. The tax-aware investing process becomes a lot more efficient when incorporated with Adhesion’s technology and overlay managers. Adhesion also allows advisors to streamline new client transactions with tax aware roadmaps. The Adhesion Advantage significantly augments advisors’ ability to add tax alpha and show clients real value.

Learn more by viewing our Adhesion Tax Alpha video (click here).

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Tax Alpha May Be Adding More Value Than You Think

In the current climate it makes sense that tax alpha would be especially relevant.  In fact, tax alpha may be the best alpha, according to a Financial Advisor IQ article entitled “Tax Alpha Isn’t Just for the Superrich.”  This is because “tax strategy is far more predictable and controllable than investment strategy,” and tax alpha has a “clear measurable impact on a client’s net worth.”

Though ultra-wealthy clients certainly benefit from strategies designed to generate tax alpha, advisors can use many of the same strategies with their mass affluent clients to mitigate taxes on investment earnings.  The article quotes Clint Pelfrey, President of Prosperity Capital with an AUM of $350 million: “The middle-class millionaire, with IRAs and 401(k)s, is often overlooked.  I’m not a tax expert; but as an advisor, it is a key component of what I work on with clients.”  For Stephen Horan of the CFA Institute, tax-loss harvesting and holding-period strategies are simple and effective ways for advisors to reduce a client’s tax liability.  Horan points out that tax-loss harvesting should be done throughout the year and ideally over the course of several years.  Advisors should also be aware that they can lower their clients’ taxes by simply holding securities for over a year rather than a year or less.  Waiting a few days can mean the difference between a capital gain being short-term or long-term.  Ensuring that a client’s capital gain will be long-term can shield the client from additional tax liability as discussed below.

As 2014 comes to a close, taxes will be front of mind for many investors.

This presents advisors with important opportunities to address tax pain points, and in doing so gain competitive advantages.  A recent article in Financial Planning, “Help Clients Cut Capital Gains Taxes,” discusses the upcoming opportunities advisors will have to add Tax Alpha by reducing their clients’ tax liabilities.  This is of particular importance this year, since many mutual funds will likely be paying out sizable distributions.  The article states: “With equity markets having experienced strong gains over the past five years, some pundits predict mutual fund distributions for 2014 will be in the neighborhood of 16%- 17% of the investment value ….” (Article cites findings from Reuters).  The negative tax implications for investors receiving capital gains will be especially significant for 2014 due to the higher tax rates that have been in effect since 2013.

With taxable distributions for many investors going “from bad to worse,” advisors can be of great help to their clients by finding ways to add tax alpha.  For example, long-term capital gains will be much preferable to short term since the long-term rate is considerably lower.  While advisors do not get to decide how distributions are characterized, the article points out that “depending on your client’s individual situation, the investment process may be able to defer the gain recognition until a later date, which can have a powerful impact on compounding over time.”  Advisors will be well-served by understanding the specific investment process that is generating the after-tax return and taxable distributions to determine whether it’s designed to manage taxes.  Financial Planning suggests that investment processes more likely to reduce a client’s tax liability can include some of the following strategies:

  • Tax lot swapping
  • Manage holding periods
  • Defer realizing gains
  • Tax loss harvesting
  • Minimize wash sales
  • Optimal tax lot selection

High-performing advisory firms can save time and resources by automating key tax aware strategies.  Too many advisors are still using obsolete tools to conduct their tax management.  The Adhesion Advantage allows advisors to streamline new client transitions with tax aware roadmaps, and much more.

Check out our Adhesion Tax Alpha video to learn more.

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Investors Poised to Take Tax Hits as Mutual Funds and ETFs see Big Gains

Taxes are definitely on your clients’ radar this year.  Both mutual funds and ETFs have seen big gains and sizable distributions this year.  As you are well aware, the bad news is that the ongoing bull market has greatly diminished the losses that managers can normally use to offset their clients’ gains; especially since the big losses of 2008-2009 have already been used to offset gains made over the past few years.  The Wall Street Journal addressed this issue in a recent article: “Minimizing the Cap-Gains Tax Hit.”  The stakes have been raised for your most important clients, and now is the time for advisors to step up and add value through creating Tax Alpha.

Mark Wilson, chief investment officer at The Tarbox Group Inc. of Newport Beach, has tracked capital-gains distribution information for the funds he uses in his clients’ portfolios for 17 years.  This year he has expanded his search to mutual funds across the board (Check out his no-charge website for tracking gains at capgainsvalet.com). He has gathered distribution information on 153 mutual funds so far, and has found that the estimated payouts are “surprisingly high.”  53 of these funds will pay out distributions of 20% or more.  The result is that advisors are looking for other ways to protect their clients from potential tax hits other than offsetting gains.

One approach advisors can use is to delay buying into a fund if it’s due for a large payout.  For example, this year Mr. Wilson delayed buying shares of Artisan Mid-Cap fund so his clients would avoid receiving a November 19 payout worth about 10% of the fund’s net asset value.  In other words, Wilson’s proactive tax management strategy actually led to an increase in the value of his clients’ portfolios.  This bull market has created opportunities for advisors to generate tax alpha by deferring gains and reducing clients’ overall tax liability.

Another proactive tax management strategy advisors can utilize is weighing the tax consequences of a big distribution versus the gain a client would receive from making a sale in a taxable account.  If a fund that is already underperforming announces a distribution, this will often tip the scales in favor of making a sale.  Timothy Parker, a partner at Regency Wealth Management in Ramsey, NJ, pointed out: “The last thing investors in taxable accounts need on top of a fund that hasn’t appreciated in the last year is a tax bill.”

Advisors can reduce clients’ tax liability and add excess portfolio value by employing an active and proactive tax management strategy.  Or as the WSJ puts it, “Efforts to minimize capital-gains taxes usually begin long before estimated distributions become an issue.”  Scott Keller, a principal at Truepoint Wealth Counsel of Cincinnati, employs a tax strategy that includes buying into funds with relatively low turnover and using rebalancing software that harvests losses when an asset class underperforms.

In today’s market even ETFs are vulnerable to tax issues.   According to Dan Moisand, principal at Moisand Fitzgerald Tamayo of Melbourne, FL, though mainstream ETFs are generally highly tax efficient, in past years the distributions on some leveraged or non-mainstream ETFs have had some abnormal gains.  The Vanguard Group has 9 U.S. bond ETFs that are expected to have modest payouts due to the historically low interest rates.

With a 5-year bull market making it yet again tricky to navigate taxes, it’s more important than ever for advisors to implement an active tax management approach and become aware of opportunities to generate tax alpha for clients.  In this climate, many opportunities exist to shield clients from their overall tax liability by opportunistically building up losses to counterbalance gains, limiting additional gains or even deferring gains entirely.

Advisors on the Adhesion Wealth platform deliver more “tax alpha” through a sophisticated tax aware management process. Learn more about Adhesion’s Tax Alpha from our webinar.

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