Reducing the impact of taxes is one of the best ways to help clients keep more of their wealth. Indeed, high-net-worth clients continue to rank tax management solutions as their top financial need. Advisors can help clients stay one step ahead of the drag from taxes by taking advantage of the unique tax-management opportunities that exist during each of the three key phases of an advisor-client lifecycle:
The cycle begins: As a client transitions assets to an advisor, opportunities often arise to manage large unrealized capital gains and concentrated stock positions.
The investment phase: During the main wealth-building phase of a client’s investment lifecycle, tax-loss harvesting can contribute meaningfully to growing and compounding returns over time.
The access phase: When a client’s investment accounts are eventually used to provide retirement income or as a source of gifting and inheritance, a different set of tax-efficient strategies can be used to preserve wealth.
A separately managed account (SMA) using intelligent tax technology offers critical advantages to help advisors and investment managers tailor solutions to each client’s individual tax situation, investment objectives and risk tolerance.
The cycle begins: Transitioning assets into a Tax-Smart SMA
When an advisor begins a relationship with a client, there is a key moment when the client shares what they are currently invested in and what they’re expecting in the near term. Occasionally, a client comes in with a well-structured, diversified portfolio. Sometimes a client is anticipating a liquidity event and will have fresh cash that needs to be put to work.
More frequently, however, a client comes in with existing investments that have deep embedded gains that need to be sold to get to the desired investment outcome. This forces a choice for the advisor and client: How much in capital gains tax would the client be willing to pay to move toward the desired investment outcome? The more capital gains that a client is willing to realize, the quicker the portfolio can be diversified or its structure improved — but this comes at the obvious cost of a capital gains tax liability. This trade-off may not be easy to make or even consider, but it is often necessary.
J.P. Morgan’s Tax-Smart platform provides a framework (and web-based interface) to help the advisor manage this transition trade-off, as discussed in “Tax-Managed Solutions for Portfolio Transitions.” In a tax-managed transition, an advisor can control how much a client may pay in taxes on “day one” of an investment relationship via the sale of a portion of the client’s legacy assets. These proceeds are then used to start aligning the account to its target exposure and provide a base of assets, which can be used for tax-loss harvesting. Ideally, over time, losses harvested from these new assets can be used to offset gains from continued sales of the legacy assets, moving an account’s transition along in a tax-efficient manner.
An additional but powerful benefit from this service is a risk-based portfolio construction approach that can help clients move toward their investment target more quickly than with a commingled vehicle, such as a mutual fund or ETF.
This benefit is greatest for clients who have concentrated stock positions, which present key risks. As shown in the research from the 2021 special edition of Michael Cembalest’s “Eye on the Market: The Agony & The Ecstasy,” more than 40% of companies that were ever in the Russell 3000 experienced a catastrophic loss —meaning a 70% decline in price from peak levels that is not recovered — while over 60% underperformed the index, highlighting the risk posed by concentrated stock positions.
Managing and optimizing portfolios with Tax-Smart strategies
Over the course of your relationship with your clients, you can help them maximize the power of compounding by minimizing tax drag. After transitioning assets smartly and building wealth efficiently over time, help your clients optimize how they access their wealth by spending from tax lots with the highest basis and gifting from those with the lowest. Tax-managed SMAs provide you and your clients with the most flexibility to stay one step ahead of taxes at each stage of the client-advisor lifecycle.