An AssetMark Company - Learn More

What is Overlay in Tax Management? Why Does it Matter to Financial Advisors?

By Adhesion Wealth, An AssetMark Company

Start With End in Mind Blog Hero 9 20 22

In tax management, "overlay" refers to integrating tax considerations into the investment process, where asset allocation, capital gain/loss harvesting, and managing taxable income streams are strategically balanced in an effort to optimize the after-tax returns for the investor.

What is Tax Overlay?

Tax overlay is a financial strategy that seeks to optimize a portfolio's investment decisions with a focus on minimizing tax liabilities and maximizing after-tax returns. It's a technique commonly used by investment advisors and wealth managers to help their clients make more tax-efficient investment choices.

Tax overlay revolves around the idea that taxes can significantly impact an investor's overall returns. When investments generate gains, those gains are subject to taxation, and the timing and structure of these tax payments can affect the ultimate profitability of the portfolio. Tax overlay strategies aim to achieve the following objectives:

  1. Tax-Loss Harvesting: This involves strategically selling investments that have experienced losses to offset capital gains and reduce overall tax liabilities. The losses can be used to offset gains with the goal of minimizing the amount of taxes owed on profitable investments.
  2. Tax-Efficient Fund Selection: Advisors may recommend investments that are structured to minimize taxable events, such as low turnover index funds or tax-managed funds. These funds are designed to generate fewer capital gains distributions, reducing the tax burden on investors.
  3. Tax-Efficient Rebalancing: As portfolios shift due to market movements, advisors may use tax overlay strategies to rebalance the portfolio in a way that can minimize taxes. This might involve selling winners and losers in a tax-efficient manner.
  4. Tax-aware Asset Allocation: Advisors consider the tax implications of various asset allocation choices and recommend strategies that align with the client's tax situation and investment goals.

Why Advisors Should Care

For financial advisors, understanding and implementing overlay in tax management can be a cornerstone for achieving their clients' financial goals. This approach not only helps to optimize after-tax returns but may also play a crucial role in establishing trust and satisfaction among clients. Below, we explore several reasons why we believe advisors should prioritize incorporating overlay in tax management into their practice:

  1. Enhanced Returns: By minimizing taxes, advisors can potentially increase the after-tax returns of their clients' portfolios. This can lead to better long-term wealth accumulation and investment success.
  2. Client Satisfaction: Clients are generally concerned about their after-tax returns. Advisors who can effectively implement tax overlay strategies demonstrate their value by helping clients keep more of their investment gains.
  3. Differentiation: Providing tax overlay services can set advisors apart from competitors. Clients who understand the impact of taxes on their investments may be more likely to choose advisors who offer these value-added services.
  4. Long-Term Relationship: Implementing tax overlay strategies can suggest that advisors are looking out for their clients' best interests, fostering trust and potentially leading to longer-lasting client relationships.
  5. Adapting to Regulations: Tax laws and regulations change over time. Advisors who stay informed about these changes and adjust their strategies accordingly can help clients navigate the complexities of the tax landscape.

In essence, tax overlay is about optimizing investment decisions within the context of an investor's tax situation. Advisors who incorporate tax overlay strategies into their services can potentially help their clients achieve better after-tax investment outcomes, thereby solidifying their role as valuable financial partners.

In conclusion, overlay in tax management can be a pivotal strategy for financial advisors aiming to optimize their clients' after-tax returns and navigate the intricacies of ever-evolving tax regulations. By embracing this approach, advisors may not only distinguish themselves in a competitive market but also foster trust and long-term relationships with their clients, reinforcing their value as indispensable partners in achieving financial goals. The nuanced implementation of tax overlay strategies can ultimately serve to enhance client satisfaction and promote informed, tax-efficient investment choices.

To learn more about incorporating overlay in your tax management strategy, contact Adhesion Wealth.

FOR FINANCIAL PROFESSIONAL USE ONLY. Adhesion Wealth Advisor Solutions, Inc. (“Adhesion Wealth”) is an investment adviser registered with the U.S. Securities and Exchange Commission. Registration does not imply a certain level of training or skill. Investing in securities is subject to inherent investment risks, including the potential loss of principal. Adhesion Wealth does not provide personalized investment or tax advice. Where information or data is presented that has been prepared by third parties, the source of such information will be cited, and these sources have been deemed to be reliable; however, Adhesion Wealth does not warrant or independently verify the accuracy of this information. Adhesion Wealth and any such third parties are separate and unaffiliated and are not responsible for each other’s policies, products or services. Reproduction in whole or in part in any form or medium without express written permission is prohibited. “Adhesion Wealth” is a registered trademark. Other trademarks contained herein are the property of their respective owners. Adhesion Wealth believes that the information in this publication is accurate as of its publication date; however, such information is subject to change without notice. © 2020 Adhesion Wealth Advisor Solutions, Inc. All rights reserved. Investment strategies that seek to enhance after-tax performance may be unable to fully realize strategic gains or harvest losses due to various factors. Market conditions may limit the ability to generate tax losses. Tax-loss harvesting involves the risks that the new investment could perform worse than the original investment and that transaction costs could offset the tax benefit. Also, a tax-managed strategy may cause a client portfolio to hold a security in order to achieve more favorable tax treatment or to sell a security in order to create tax losses. Prospective investors should consult with a tax or legal advisor before making any investment decision.

By Adhesion Wealth, An AssetMark Company