Jack: What do you mean?
Harry: A rules-based approach is done account-by-account. Like the name says, it follows rules, which are set regardless of the portfolio. As an example, a rules-based UMH might decree that fixed income only goes in the qualified account and equities only go in taxable accounts. To be honest, the suggestions don’t often make sense to the advisor and are hard to adopt. We see adoption in the 7% to 10% range with a rules-based approach.
Jack: But that isn’t the only way to implement UMH. I know other firms like Morgan Stanley are taking a more flexible and dynamic approach.
Harry: Yes. They look at each household’s tax rates, holdings, and all accounts, and make suggestions to dynamically coordinate holdings so they are custom to the client. The advisor’s software tells the advisor the optimal asset location consistent with risk and quantifies the financial benefit.
The client’s holdings are dynamically placed in the appropriate account to maximize after-tax returns and increase household portfolio value. According to Vanguard’s value of advisors research paper, constructing a portfolio using tax-smart asset location "can add up to 75 basis points of additional return in the first year, without increasing risk."
For income planning, all the accounts and products need to be considered to create a risk-appropriate and tax-smart sequence of withdrawals. As with accumulation, minimizing taxes and quantifying the benefit is vital for withdrawals. When our enterprise clients get that, things take off.
Jack: Thanks, Harry, for the UMH lesson. This is a win-win-win and an exciting opportunity for investors, advisors and firms.
Jack Sharry is co-chair of MMI's Digital Advice Community, sits on the Next Chapter Advisory Council, is host of the WealthTech on Deck podcast, author of the book Authentic and Ethical Persuasion, and is the executive vice president of LifeYield.