Tax planning doesn’t stop on Tax Day

My father, Paul A. Samuelson, and I shared the same name and a strong interest in personal investing. While his primary job was professor of economics at MIT, he took on various investment advisory roles and served for many decades as a trustee of TIAA-CREF.

As a young portfolio manager and MIT finance Ph.D., I could give him some practical insights into how trading was done and investment strategies were managed and sold, while he as a noted economist and Nobel Laureate could provide insights on every financial topic. We talked a lot about personal investing and what advice to give family and friends that they might follow.

Our investment problem was simple. We had a long investment horizon and high risk tolerance so we could buy and hold diversified stocks, combining U.S. and international index funds, and Berkshire Hathaway because it paid no dividends and made no other distributions. Our investment expenses were less than .2% and we paid taxes on only a small amount of dividends. We could only reduce our investment taxes by holding stocks with lower yields in our taxable accounts and those with higher yields in our IRAs, and by occasionally realizing a capital loss.

The investment problems of our friends and other family members were not so simple. They were more risk-averse and needed to hold bonds as well as stocks. They sometimes needed to make withdrawals from their investment accounts, faced various tax rates on investment income and gains, and had disorganized assortments of IRAs, 401(k)s and brokerage accounts. We still gave investment advice about reducing costs and taxes at cocktail parties and soccer games, but fully appreciated how much more guidance was required.

Most investors have many investment accounts with different tax treatments and an almost random assortment of assets. Various advisers manage specific accounts, while other accounts are orphaned. Most investors would benefit from a single adviser who took a holistic view of all their accounts and focused on reducing expenses and taxes on investment income and gains.

With Tax Day 2018 behind us, most financial advisers have directed their attention elsewhere. But Tax Day represents only 1/365th of the entire year. Minimizing taxes can and should be an ongoing and critically important year-round pursuit.

The first and most important advice to provide clients is to take full advantage of asset location. Simply put, asset location is a process by which tax-efficient assets are located in taxable accounts and tax-inefficient assets are held in IRAs or 401(k) accounts. Morningstar Inc. did a study showing optimal asset location can add 52 basis points per year in incremental after-tax returns.

For example, a $500,000 portfolio with assets split equally between taxable and qualified accounts projects to $1,153,000 portfolio after 20 years and a 4.5% after-tax annual return. Employing a tax-smart asset location strategy yields a $1,286,535 portfolio after 20 years with a 5.1% after tax annual return, or an annual improvement of 60 basis points. Clearly, investors would welcome an improved investor outcome of $133,535 without having to take any additional risk by holding their assets in the optimal account registrations.

You have probably heard the expression, “It’s not what you make, it’s what you keep.” Minimizing taxes helps investors make more and keep more. After many attempts to tell friends how to manage their portfolios in a tax-efficient way, it became evident that advisers didn’t have the tools and didn’t have access to investors’ entire portfolios to implement a tax efficient strategy.

Now, as technology continues to make significant advances, forward-thinking advisers and firms like Morgan Stanley are leveraging tax-efficient portfolio strategies to differentiate themselves and win and retain clients.

Advisers can demonstrate the value of asset location and intelligent withdrawals, they can quantify the benefits to their clients, and importantly, they find investors are inclined to consolidate assets with them.

“My clients are using tax efficiency strategies to not only save money but generate larger retirement paychecks,” said James Loftin, the CEO and co-founder of GER Loftin Wealth Advisors, an affiliated financial adviser of United Planners. “I have found that taking a 365-day-a-year approach to tax planning has enabled me to not only deliver more value but to increase the assets that I manage for clients, as the most effective tax-management strategies involve an investor’s entire portfolio, not bits and pieces.”

My father was always curious about how things actually got done. Forty years ago, we could recommend some low-cost and minimally taxed index funds but could not show our friends how to use them.

It would amuse him to see the investment software available to support advisers in implementing tax-efficient strategies for their clients. It would gratify him that a broad array of clients can get the investment advice and results they deserve.

(More: A smarter way to rebalance)

Paul R. Samuelson is co-founder and chief investment officer at LifeYield, which provides digitally enhanced portfolio advice.