Like rebalancing, tax planning is not just an annual event: here’s why
Studies show that managing tax implications is one of the most compelling ways an advisor can add value by helping their clients experience improved returns and income on their portfolios. Tax planning should be a year-round activity—not just an annual event centered on tax season. Rebalancing plays a crucial role to ensure investment policies and tax efficiency goals are consistently met.
With that in mind, market experts are telling advisors, investment managers and investors to brace themselves for continued stock market volatility in 2021. Following the bumpy ride of 2020, more advisors are talking with clients about ways to take tax-smart approaches to asset location, transitions between portfolios, household-level management and rebalancing, and tax-loss harvesting.
There are several key ways advisors can ensure their rebalancing and trading remain in sync with their clients’ tax requirements and objectives.
Tax-aware rebalancing helps the advisor reduce or eliminate the client’s tax consequences. Asset location optimization, tax-loss harvesting at the position or tax lot level, and capital gains budgeting are powerful ways for advisors to enhance their ability to meet their clients’ specific tax strategy.
Establishing capital gains rules across taxable portfolios helps control your clients’ annual tax burdens. Applying unlimited sets of tax rules, custom thresholds, target overrides, and location preferences are other key rebalancing features advisors use to help clients maximize tax efficiencies.
Householding structures help advisors meet their clients’ increasing demand for tax efficiencies. Reviewing a client’s risk profile holistically across all accounts within a household is also crucial to assess the proper alignment between risk tolerances, preferences and capital gains budgets. A rebalancing solution should offer wash sales logic across the household to maximize tax efficiencies.
Optimizing the location of assets in various types of accounts can significantly reduce the tax impact of the portfolio. Therefore, rebalancing should also enable the advisor to define location preferences across taxable, tax deferred and tax-exempt statuses.
Increasingly, advisors are leveraging what-if scenarios on model allocation changes or tax-loss harvesting events. With the right solution, advisors can test different types of scenarios across their entire client base or a subset.
Harvesting tax losses or gains
Many experts say 2020 was a banner year for tax-loss harvesting. With ongoing and anticipated increases in market volatility, an advisor’s clients may at some point find themselves again sitting on losses that can be harvested to offset capital gains and enable asset allocation repositioning, while maintaining their desired portfolio allocations.
Rebalancing should allow advisors to easily harvest tax gains or losses and utilize substitute securities to maintain market exposure, while avoiding potential wash sales. It should also provide capabilities for:
Realizing gains or losses at the position or classification level, and holistically across portfolios
Factoring in restrictions, minimum trade size, and loss or gain thresholds to influence trade recommendations
Offering different methods of harvesting gains and losses including closing the position, selling lots based on cost basis method, and selling specific lots
What clients want
Today’s affluent clients want more transparency, reduced tax burdens, wealth and asset preservation. With a greater focus on tax efficiency, and the help of a powerful tax-aware rebalancing solution, advisors can spark deeper client conversations, help clients become wealthier, and grow their practices.