Advisors: Have a Tax Management Plan for Portfolios

As the possibility of higher tax rates looms, portfolio tax management is taking on heightened importance for financial advisors and their clients.

Budget negotiations in Congress include the potential for higher tax rates for individuals and corporations, as well as higher capital gains taxes. Investors have expected tax levies to rise in some cases when the rate levels installed by the 2017 Tax Cuts and Jobs Act expire, but talks in Congress could raise those levels sooner.

How it all will unfold remains to be seen, but David Lebovitz, global market strategist at J.P. Morgan Asset Management, says his firm believes that tax rates are moving higher and that it may happen sooner than expected. He spoke Oct. 20 at the Schwab Impact conference.

Combine that with heightened stock volatility, higher inflation, low fixed-income yields and potentially weaker U.S. equity returns, and financial advisors may want to consider thoughtful tax management, he says.

Making a portfolio tax-efficient is important, but experts say advisors shouldn’t make it the main factor when managing a portfolio. Here’s what financial advisors should know about tax management in portfolios.

[SUBSCRIBE: Get the weekly U.S. News newsletter for financial advisors. ]

Tax Strategies for Advisors

Advisors should take a holistic approach to taxes, says Paul Gamble, CEO of fintech firm 55ip and another speaker at the Schwab conference.

“There’s always money coming in and out of a portfolio. So it’s critical that advisors have solutions that can help them deal with this,” he says. “Tax management is not just a year-end thing, and it’s not just about tax-loss harvesting.”

Gamble says his firm considers taxes in three different ways: How to transition a client from one portfolio to another tax-efficiently, how to deal with ongoing issues such as rebalancing and tax-loss harvesting, and how to make withdrawals in a tax-smart way.

The first step Gamble takes when considering a client’s portfolio and tax management is to understand a client’s “tax budget,” or how much they’re willing to pay in taxes, while considering their appropriate risk level and asset allocation. Then he looks at the capital gains rates for the securities the client holds to mitigate the tax burden as the firm transitions the client’s portfolio.

“You want to do tax transition in an automated way, so you can get the client on the right path. And then once you get them there, you can use the volatility in the market to continue to harvest losses, and move further and further into the strategy,” he says.

[Read: How Advisors Can Collaborate With CPAs.]

Transitioning a Portfolio

Direct indexing is one way to take advantage of portfolio transition, Gamble says, to incorporate a client’s personal preferences and individual tax rates. Direct indexing allows investors to buy the stocks of an index, instead of purchasing a mutual fund or exchange-traded fund. It’s not widely available yet, but may be soon.

Some advisors look at taxes as a way to generate alpha, or excess returns. Lebovitz says, looking at the history of capital gains tax increases going back to 1970, his firm’s research shows that two out of three times, the stock market fell in the six months leading up to the increase. Historically, six months after the tax hike, the market rallied by a fairly significant amount.

“That creates short-term volatility. That creates a near-term opportunity to use a decline in equity markets to your advantage, in an effort to generate tax alpha, recognizing that every instance we have, as well as on average, the market rallied healthfully in the aftermath of said increase in taxes,” Lebovitz says.

Some advisors will tax-loss harvest on a schedule, but Kevin Swanson, CEO of Potentia Wealth, says harvesting losses that way can lead to missed opportunities, such as using losses to offset the sale of a business or another one-time large capital gain.

“Those are the times that you really want to analyze the losses in your portfolio. So I would say understand the ‘why’ for the losses and then be intentional about it,” he says.

Investors who harvest losses also need to be aware of the wash-sale rule, which prohibits them from repurchasing the same security they have just sold for 30 days. That’s particularly important for investors who use exchange-traded funds.

[READ: Do You Need a Financial Advisor or Accountant?]

Putting Taxes in Perspective

When it comes to withdrawals and tax implications, Swanson says he uses the three-bucket approach, carving out assets using a short-, intermediate- and long-term view. Short-term needs are in a very conservative, liquid account (cash, perhaps), while the other two are in investments where taxes won’t be an immediate issue.

“In bucket two and bucket three, we’ve got those more aggressively (invested), and in bucket one, we’ve got the liquidity for roughly the next 12 months in place,” he says.

Michael Wagner, co-founder of Omnia Family Wealth, says portfolio tax management is important, but it’s not the only factor, and sometimes clients can let taxes obscure the big picture. “You don’t want to let the tax tail wag the investment dog,” he says.

That’s particularly true when it comes to portfolio rebalancing. With the market run up in the past few years, it can be very difficult for individuals to sell those winning stocks because they might not want to pay capital gains taxes.

“Nobody likes paying taxes. But the fact is, from a rebalancing perspective, it’s absolutely the right thing to do,” Wagner says.

More from U.S. News

6 Pros and Cons of Choosing a Fee-Only Financial Advisor

14 Things to Know Before Becoming a Financial Advisor

8 Ways Financial Advisors Connect With Millennial Investors

Advisors: Have a Tax Management Plan for Portfolios originally appeared on

Related Categories:

Latest News

More from WTOP

Log in to your WTOP account for notifications and alerts customized for you.

Sign up