Tax planning has role in asset allocation, expert says

CHICAGO — It often is the details that can help financial advisers manage their clients’ after-tax wealth, according…

CHICAGO — It often is the details that can help financial advisers manage their clients’ after-tax wealth, according to one adviser.
Cheryl Holland, speaking to advisers here early this month at the National Association of Personal Financial Advisors’ annual conference, reminded the audience to consider a broad range of alternatives when trying to help clients reduce their tax burden. She is an adviser with Abacus Planning Group Inc. in Columbia, S.C.
“Tax loss harvesting is not just for December but for every time you re-balance a portfolio,” Ms. Holland said.
‘Asset location decisions’
One strategy she recommended as a way to manage the taxable drag on a portfolio is to increase the focus on “asset location decisions,” which involves evaluating portfolio holdings for their tax efficiency in the context of the taxable or non-taxable accounts.
“Placing tax-inefficient funds in tax-deferred accounts makes the most sense,” Ms. Holland said. “But you will have to make your own judgments, because it will depend on how you’re executing.”
The NAPFA conference was attended by more than 800, including more than 500 adviser members of the 24-year-old association, which is based in Arlington Heights, Ill.
Although communications skills and practice management were underlying themes of this year’s conference, the idea of helping clients save on taxes is particularly appealing, according to Theodore Feight, president of Creative Financial Design in Lansing, Mich.
“The whole time [Ms. Holland] was talking, I was thinking ‘cha-ching, cha-ching,’” Mr. Feight said, suggesting the financial advantages he felt he gained from the sessions.
One idea that got Mr. Feight’s attention was the use of a so-called exchange fund to help clients diversify a particularly concentrated holding in a single stock.
Exchange funds are structured as private commingled portfolios that allow investors to pool their concentrated stock positions with other investors to gain the fund’s total return.
“I love that idea,” said Mr. Feight, who previously hadn’t heard of the unique strategy.
“I have several clients that have too much stock in one company,” he said.
Mr. Feight cited one client with a $3 million investment portfolio, including about $1.5 million concentrated in a single stock from her employer.
Exchange funds, according to some advisers familiar with the product, are known for having high management fees, and the minimum investment usually starts at $1 million, assuming the fund’s board approves the stock for inclusion in the portfolio.
Although exchange funds do help some investors diversify concentrated positions, the inclusion in the larger portfolio does alter an investor’s cost basis.
Other issues Ms. Holland addressed included the benefits of establishing Roth individual retirement accounts for children and harvesting tax losses from a 529 college savings plan.
“In a taxable environment, performance doesn’t matter,” she said. “What matters is what my client is going to keep after taxes.”
One adviser who didn’t attend Ms. Holland’s session said he strongly supported her asset location strategy when it comes to investing in vehicles that tend to have a bigger tax impact, such as certificates of deposit, real estate, some bonds, commodities and international equities.
“It used to be advisers focused on trying to defer taxes, but that’s like deferring the flu,” said John Henry McDonald, chief executive of Austin (Texas) Asset Management Co. “If your pre-retirement planning is just about deferring taxes, and you put everything in qualified plans, then it comes out when you retire and throws you into a higher tax bracket.”
The idea, Mr. McDonald said, concurring with Ms. Holland’s advice, is to pay attention to the tax implications of the various products that make up a client’s portfolio and to create a balance that includes paying some taxes now and deferring some until after retirement.
For instance, he said, with taxes on capital gains at a historical low of 15%, it makes more sense to hold more investments that generate capital gains in non-qualified plans.