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With trillions of dollars changing hands in the blink of an eye, the world of finance is dynamic, making staying ahead of the curve (and competitors) paramount. In fact, Deloitte estimates that by 2030, Americans will have amassed a staggering $64 trillion in investable assets. With such colossal wealth in play, the demand for financial advisors equipped with the expertise to navigate the complex terrain of tax planning and wealth management optimization strategies has never been higher.
In the quest to secure a competitive edge in the advisory landscape, Russell Investments’ 2022 Value of an Advisor study unveiled a pivotal insight: advisors who adeptly assist clients in implementing tax-intelligent investing strategies can effectively differentiate their practice. This finding underscores the ever-growing significance of tax optimization in the wealth management realm.
Russell Investments further elaborates on the consequences of neglecting tax considerations. Investors in non-tax-managed U.S. equity products, encompassing active, passive and ETFs, found themselves relinquishing an average of 2.14 percent of their returns to the clutches of taxation. In stark contrast, those who entrusted their investments to tax-managed funds witnessed a significantly lower tax burden, forfeiting just 0.92 percent of their returns.
This stark contrast translates into an impressive 1.20 percent gap in annual savings. In monetary terms, this equates to an astounding $600 billion opportunity for advisors to demonstrate their prowess by capturing tax alpha for their clients.
Pursuing tax alpha
This opportunity lies in understanding the concept of tax drag, the erosion of a portfolio’s annualized return due to taxes triggered by distributions and capital gains in non-qualified investment accounts. In simpler terms, it’s about recognizing how taxes dilute returns on client investments. Advisors well-versed in tax optimization strategies are poised to seize a piece of the $600 billion windfall for their clients.
A shift in perspective is crucial for advisors seeking to add value beyond measures such as “performance” or “market returns.” Comprehensive financial advice must prioritize after-tax performance of assets to unlock potential benefits, including enhanced portfolio returns, effective risk management, client-centric planning and more accurate financial projections. This is vital when estimating post-retirement income and expenses, which is necessary to answer the age-old question: “Am I going to outlive my money?”
Because decumulation can be just as important as accumulating wealth, advisors who deploy tax optimization strategies can plot a strategic course to help clients achieve their financial objectives, utilizing a where, what, how and when approach. By judiciously selecting where to invest, they can implement asset allocation strategies that spread investments across taxable and tax-deferred account types, maximizing tax efficiency by selecting the products and solutions that best align with a client’s unique tax and financial situation (the what). Advisors can effectively manage those investments in a tax-intelligent way (the how) by employing tactics designed to minimize capital gains and to avert large, one-time tax expenditures. Knowing when to realize income by drawing upon proven distribution strategies to bolster a client’s financial security is as critical as the first several components.
Partnership can overcome inherent challenges
The path to increasing tax alpha is not without its challenges. Advisors aiming to build tax-intelligent practices must clear two primary hurdles: time and access to information. The intricacies of tax laws and regulations can be overwhelming, demanding a significant investment of time and effort to stay abreast of the latest developments. Access to relevant, timely and accurate information – and the experience to accurately interpret it all – is critical to making informed, tax-intelligent decisions.
Nonetheless, these challenges are by no means insurmountable. Advisors can adopt a proactive approach by seeking both resources and partnerships with experts. Harnessing technology and tools that assist in tax-efficient investing can significantly streamline the process for advisors. This in turn can empower them to simultaneously enhance their practice’s efficiency overall while offering substantial benefits to their clients, who increasingly want their financial advisor to also provide tax planning and advice.
There is no “silver bullet,” but savvy advisors realize the importance of collaborating with a network of tax experts to leverage their insights in a strategic manner. Maximizing tax alpha for clients is not just a niche strategy but a vital component of comprehensive financial planning. It empowers advisors to capture their piece of the $600 billion opportunity and differentiate their practice, while providing unparalleled service and value to their clients.
Andy Watts, CFP,® is vice president of Planning and Growth Solutions at Avantax.
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