The first step of asset location is to identify tax-inefficient assets which can increase the out of pocket costs for clients and decrease the performance of their portfolios. Certain assets are inherently tax-efficient—such as tax-free muni bonds, ETFs, index funds, and buy and hold equities which are taxed at lower long-term capital gains rates. Certain assets are inherently tax-inefficient—such as fixed-income, commodities, REITs, liquid alts and actively traded strategies—which generate ordinary income or short-term gains that are taxed at higher ordinary income rates. When evaluating assets, key indicators of tax-inefficiencies include yield, the use of active management verses buy and hold strategies, and the tax cost ratio, which measures the impact of taxes on a fund’s annualized return.
Next identify the right combination of tax-deferred, taxable and tax-free accounts to offer clients greater flexibility and improve retirement savings potential. Locate tax-efficient assets in taxable accounts and locate tax-inefficient assets in tax-free and tax-deferred vehicles, to preserve all of the upside without the drag of higher taxes. Start by maxing out qualified plans. But for high earners and the high-net-worth, who can easily surpass the low contribution limits of 401(k)s and IRAs, a category of investment-only variable annuities (IOVAs) are designed to maximize the power of tax deferral. Simple and transparent, with low fees, or even flat-fees, no commissions, no surrender charges, and an expanded lineup with hundreds of underlying funds, low-cost IOVAs can be used as a tax-advantaged investing solution with virtually no contribution limits.
The integration of smart technology is one more way to improve your approach to tax-efficient retirement planning and provide a more holistic approach for your clients. Efficient and intuitive tax-optimization tools can help you manage client portfolios in a tax-efficient manner by continually monitoring client holdings and performing pre-trade analysis, to identify tax inefficiencies and tax-loss harvesting opportunities, minimize the tax implications of trading activity and increase after-tax returns. According to Advisor Authority, the most successful advisors—those who earn annual income of more than $500,000 or individually manage AUM of $250 million or more—say tax-optimization tools are among the top three new technologies they will integrate into their practice over the next 12 months
Adapt—Or Be Left Behind
Change continues at an unprecedented pace. As Americans are living longer while pensions plans disappear, health-care costs increase, and the future of Social Security remains unclear, the “Retirement Income Challenge” is real—and growing. As the most dramatic tax reform package in nearly three decades takes hold, it has the potential to impact every client, from the least affluent to the highest net worth. Advisors and clients alike must adapt—or be left behind.
In a complex world, one of the top reasons that investors work with an advisor is to feel more confident in their financial future. Preparing for a retirement that could last for 20 to 30 years or more, while facing uncertainties in an age of tax reform, there are many unknowns. More investors will seek your holistic and unbiased advice as this ongoing cycle of change and uncertainty impacts their ability to reach long-term goals.
So control what you can. Take a holistic approach to tax-efficient retirement planning based on the foundation of asset location. Keep costs low and maximize the power of tax deferral over the long term with solutions such as innovative IOVAs. Leverage smart technology to manage complex tax challenges and potentially protect clients from losing out because of tax-inefficient portfolios. The value proposition is simple and powerful. There’s a clear relationship between minimizing taxes—and increasing returns without increasing risk. This could mean a more secure retirement for your clients—and a more secure future for your firm.
Craig Hawley is the head of Nationwide Advisory Solutions.