How To Use Direct Indexing To Offset Taxes on a Future Financial Windfall

Executive summary:

  • The sale of a business, property, or large stock position can generate a financial windfall that may trigger a large tax liability
  • A Direct Indexing strategy can help manage these tax burdens, either over a set timeframe or with an annual tax budget
  • Advisors may benefit from happy clients who could provide a referral

Many high-net-worth individuals are planning on selling a business, property, or large stock position in the future. These types of sales typically generate a significant capital gains tax liability that needs to be planned for years in advance. Unfortunately, many advisors fail to help clients look this far into the future and have yet to put a plan in place.

This gap could provide an opportunity for you to introduce Direct Indexing. With Direct Indexing, investors can manage their portfolios in a way that minimizes capital gains taxes by selectively harvesting losses, offsetting gains, and implementing tax-efficient trading strategies.

A Direct Indexing strategy can potentially earn a return similar to a chosen benchmark – while simultaneously harvesting losses that can be stockpiled to offset the future capital gain. This can help the investor manage their tax liabilities and potentially reduce the taxes due on the future financial windfall. Starting this process early gives the client (and you) plenty of time to adapt and adjust over time as the markets move—and as the investor's situation evolves.

First, identify the potential for your client to realize a windfall. This may depend on how close they are to retiring or making another significant life change. Once you and your client determine the source of the future windfall and the timing, you can then explain to your client how to use Direct Indexing to either reduce the potential tax liability over time or manage the tax liability within a certain budget parameter.