Tax management strategies like harvesting, which involves selling any number of products once they dip, reporting the loss and then buying back into the same or a similar position after a certain amount of time, can help hedge against capital gains taxes and enhance your client’s portfolio, the Chicago, Illinois-based tech firm said in a presentation.
“As we’re heading toward the year end, this usually is when the tax harvesting season begins, and with the election there’s a little uncertainty with what may happen with capital gains and ordinary income tax at the moment,” Brandon Thomas, the chief investment officer at Envestnet, said. “It’s likely that, at best, rates will stay the same.”
Moreover, taxes represent the biggest bane to capital appreciation next to inflation as over 40% of the U.S. equity market is held in taxable accounts. Seventy six percent of taxable investors expect that their advisor is applying tax management techniques to their accounts, Envestnet reported.
“Advisors who do deploy these techniques, they have gotten deeper relationships with their clients,” Matthew Springer, the founder of Tamarac and managing director of advisor services at Envestnet, said. “It’s a way to open the door to more asset gathering.”
According to Springer, there are essentially two approaches: offensive loss taking and defensive tax deferrals.
Offensive would be evaluating and taking daily, monthly or quarterly loss on a portfolio or at the single security level.
“There’s also ways of taking individual securities that have a certain amount of loss and swapping those that give you the return you’re looking for,” Springer said.
He cautioned, however, that tax harvesters should be well aware of the Wash-sale Rule, which occurs if you sell your position in a fund, for example, and then buy back the same fund within a 30-day time window. That rule can be especially important to note if you’re planning on reinvesting dividends, which counts as a buy, Springer said.
Defensive is characterized more as tax avoidance, which can be achieved by deferring gains for as long as possible. Don’t sell products that, for example, become a long-term gain within 90 days, Springer said. “There is a rule of thumb that if the security that you have with a gain is going to get around 90% of the return of any security that you could replace it with, it’s best to keep your security and not take the gain.”
Another organizational tip for tax management is to advise at the household level and aggregate groups of accounts and investments such as IRAs and fixed income and manage them according to one model. For example, keep bonds in tax-deferred accounts and stocks in taxable accounts.
“What it also does is minimize transaction costs because you’re not taking every account and trying to match it to the same model,” Springer explained. “It just makes the management of the account quite a bit easier.”
Grouping can also open up access to more areas of a client’s wealth as advisors can help harvest losses to benefit some long-term gains in another area, if a client is selling some real estate investment, for example, and wants to leverage some prior losses on the balance sheet.
“You’re able to get a lot more of your clients wallet than just managing one account,” Springer said. “The benefit is accrued to both the advisor and the investor.”