At a recent meeting in Dallas, an advisor shared that his client paid a total of just 14 basis points for his advisor services through the effective use of tax loss harvesting to offset gains. How does this work?
Increasingly, superior tax management is a critical and necessary component of a financial advisor's practice. Through this added counsel, you can provide significant value for clients in several ways: 1. by offsetting gains with losses throughout the year; 2. through banking losses for later use in offsetting gains; 3. through management of the tax consequences for taxable IRA and 401(k) distributions; 4. for retiring boomers who choose between actual retirement and new careers; 5. and through "banking" losses generated in the current financial crisis. Let's look at a few of these options.
Many advisors focus on tax planning only at year-end -- especially tax-loss selling strategies. In reality, it's always a good time to consider how tax management can affect the portfolio as a whole. Your affluent clients, in particular, need more than just reliable investment solutions. They need a comprehensive, year-round approach that takes into consideration current holdings, financial objectives, long-range planning concerns, potential life changes, inheritance -- and, of course, tax efficiencies. Even the smallest change made to a client's investment portfolio can have a positive tax implication. And while often overlooked, the intersection of tax management and transition planning are critical components when transferring assets to a diversified portfolio that meets your client's desired goals. Plus, when you spend time with clients on tax solutions, you create a competitive advantage for your practice that could help transition relationships well into the next generation.
For example, a client with $30,000 in unrealized losses could participate in tax-loss harvesting, and potentially harvest the entire $30,000. Assuming a combined federal/state marginal tax bracket of 28 percent, your client would have a net savings of $8,400 -- not to mention a potentially better-positioned portfolio.
During the fourth quarter, skilled advisors turn their attention to tax-loss selling, actively selling securities below market value to realize capital losses inside and outside of a portfolio. While current market volatility has no doubt caused you and your clients anxiety, the pendulum always swings back, making tax-loss selling especially important in current markets for two reasons. One, you can lower a client's overall tax consequences at the end of a calendar year. Two, these losses can be "banked," and used in future years to offset capital gains.
For example, any losses you don't use this year can be carried forward indefinitely (according to current tax law). Say a client has $30,000 in losses, and $25,000 in capital gains. That investor can take that $25,000 plus an additional $3,000 as allowed currently by the IRS for a net loss of $28,000. They can carry the $2,000 left into future years.
Just as important, harvesting can generate a loss outside of a portfolio. For example, if your client is planning to sell a business, you could potentially create a bank of losses to help offset the gain on the sale of the business.
Or, consider the following scenario: An investor has $250,000 gross proceeds from the sale of a business, with a cost basis of $200,000. So there is a gain of $50,000. In their portfolio, the same investor has a loss of $130,000 and a gain of $100,000, resulting in a net loss of $30,000. That $30,000 loss can then be used to offset $30,000 of the $50,000 gain from the sale of the business.
As I mentioned at the outset, when advisors offer skilled tax management, the windfall for clients expands beyond the tax savings alone. A breakdown of fees saved by our clients reveals that 30 percent of clients saved 100 percent of annual advisor fees; 34 percent saved at least 50 percent and; thirty-six percent reduced advisor fees by at least 25 percent.
Charles Widger is Chairman and CEO of Brinker Capital, an investment management firm. For more information, visit www.brinkercapital.com.
