Investors continue to cite taxes among their top financial concerns–regardless of net worth. Our fifth annual Advisor Authority study of nearly 1,600 RIAs, fee-based advisors and individual investors found taxes are the second top financial concern among investors, falling only behind the cost of health care. For more affluent investors, including the High Net Worth, with investable financial assets of $1 million to less than $5 million, and the Ultra High Net Worth, with investable financial assets of $5 million or more, taxes are their number-one financial concern.
Advisors have taken note of investors’ concerns. The number of RIAs and fee-based advisors who say that their clients will benefit from tax reform declined ten full percentage points this year—to 69% in 2019 from 79% in 2018—and three-in-four RIAs and fee-based advisors (75%) have adapted their approach to tax-advantaged investing.
Focus on four year-end tax planning strategies to set your clients up for success, ahead of the 2019 tax season.
1. Tax-Efficient Investing Starts with Asset Location
Different investments have different tax impacts, and some are inherently more tax-efficient than others. Asset location is a proven strategy that can mitigate the impact of taxes by locating assets between taxable and tax-deferred vehicles, based on their tax-efficiency. By helping to increase returns for investors, without increasing risk, the savings and potential wealth generated through asset location can be substantial, especially for investors who fall within higher tax brackets.
Locate tax-efficient investments, such as index funds, ETFs, tax-exempt municipal bonds and buy and hold equities in taxable accounts. Locate tax-inefficient investments such as fixed income, REITS, commodities, liquid alternatives or other actively managed strategies in tax-deferred vehicles. Start with qualified plans such as an IRA or 401(k). Once qualified plans are maxed-out, consider low-cost investment only variable annuities (IOVAs). This allows you to preserve all of the upside, without the drag of taxes.
2. Proactively Manage Mutual Fund Distributions
The day before Thanksgiving, the Dow Jones Industrial Average closed at a record high of 28,164.00 points. This year, as the bull market continues its run, mutual funds continue to accrue net gains and income, and clients need to be prepared for potentially higher year-end mutual fund distributions.
In particular, clients holding actively managed mutual funds might receive large tax bills this year because the combination of higher returns and record outflows has forced many managers to sell winning positions. Likewise, record drops in bond markets drove increased trading by managers this year, causing a tax hit for many bond-fund investors.
Locating mutual funds in a tax-deferred wrapper, such as an IRA, 401(k) or low-cost IOVA, can mitigate the potential impact of taxes of year-end distributions, allowing clients to keep more of these gains.