Cutting Gordian Knot Of Tax As Income Hunger Grows

Tom Burroughes Group Editor June 15, 2021

Cutting Gordian Knot Of Tax As Income Hunger Grows

Taxes are likely going up, complexity of investments is increasing and many HNW families hold wealth in a jumble of funds and direct holdings. Putting assets into a single framework isn't just about being tidy, it can save a hefty tax bill.

The wealth and investment management sector tends to focus mostly on building up wealth and considering the tax implications rather than the decumulation process, a figure working with the North American sector says.

The aging of the Baby Boomer generation and shifts in wealth to the next generation, coupled with expected tax hikes from the Biden administration, creates complexity. With many high net worth individuals and families holding disparate “buckets” of assets – liquid and illiquid – achieving the most tax-efficient result to gain the best income result requires a helicopter-like view of everything HNWs hold. All too often, when families accumulate investments over the years and in different forms, they end up paying more tax than they ought. At times like this, that’s a cost they don’t need.

And the unnecessary costs of such complexity are all the more regrettable when family members retire and draw down on what they've built.

That’s the view of Steve Zuschin, executive vice president of enterprise technology adoption at LifeYield. The firm operates in the field of “household-level management,” enabling advisors to get the most income for their clients. It uses algorithms and other tech so that advisors can optimize the tax efficiency of clients’ portfolios. LifeYield manages processes such as asset location and the sequencing of withdrawals of money over time. (Asset location optimization is the choice of whether to hold stocks and bonds in taxable or sheltered accounts.)

The urgency of this area has gotten more significant in light of likely tax hikes in the US, although that’s not the only driver, he said. Demand for such services is “massive.”

More wealth management firms are having to look at people as members of households rather than as distinct individuals, given that their assets are often intertwined, he said. 

LifeYield manages investment taxes for clients and co-ordinates this work across a client’s mass of accounts so that they are treated as a coherent whole. In far too many cases, lack of a single approach means that people pay more tax than they need to, he said. 

The need for tax efficiency is particularly important when decumulation is a trend. Last week, the Boston Consulting Group’s annual overview of the world’s wealth industry singled out the topic. Wealth managers may miss out on major revenue opportunities to serve a new breed of ultra-high net worth clients and retirees who are decumulating their assets, it said.

The US has nearly 21,000 individuals whose total financial wealth exceeds $100 million, an increase of over 15 per cent over 2019, according to the BCG report. More than 7,000 people will enter the UHNW bracket in the next five years, the consulting firm estimates, bringing the total wealth of that segment to nearly $8 trillion.

Even though retirement assets make up around 12 per cent of total financial assets in the US, decumulation often marks the denouement of the client–wealth manager relationship. Too often, advisors wind down their interaction with clients in their middle and late retirement stages, leaving many retirees asset-rich and advice-poor at a time when their needs are most complex, BCG said. Individuals in the affluent and lower-end high net worth segments with between $250,000 and $5 million in wealth are especially affected by the advisory gap in the decumulation phase. 

So it appears that BCG is pushing at an open door.

Capital gains taxes
As lawmakers in Washington DC debate President Biden’s proposed doubling of capital gains taxes on HNW investors, along with a rise to federal income taxes on wealthy Americans, the need for tax efficiency ratchets up. 

In talking about capital gains taxes, any rises need to be put into perspective, LifeYields Zuschin said. “Capital gains tax is generally the result of doing a good thing and of being successful.”

For those thinking of ploys to avoid or forestall CGT, assuming that it rises as predicted, investors should remember that it is likely to be imposed retroactively, he said. 

“Now is maybe the time to start realizing gains…..and converting from an IRA to a Roth structure, and so forth,” he said. Roth IRAs are funded with after-tax dollars; the contributions are not tax-deductible. But once a person starts withdrawing funds, the money is tax-free.)

One option for some HNW investors is considering holding municipal bonds, which come with tax advantages, Zuschin said. 

“LifeYield’s software shows [whether] you have clients with taxable bond exposure that could be replaced with muni bonds,” he said. 

In a case study white paper issued by EY, LifeYield gave the case of a “Washington Household” with $1 million in IRAs and brokerage assets. LifeYield’s tax-efficient management of assets boosted assets at retirement by 19 per cent, annual retirement income by 33 per cent, and bequests by 45 per cent. Top marginal rates of tax applied to this household during the accumulation and retirement phases. The wealth of the asset household was split as follows: 80 per cent in taxable accounts, and 20 per cent in tax-advantaged accounts, the white paper said. 

Harvest gold?
Another area that can be revealed is that if a client has different lumps of assets, they may have different capital cost bases, which means that the impact of CGT on the gains in each will be different. By intelligently managing these assets, that CGT impact can be mitigated, he said. 

Tax-loss harvesting is a reactive strategy and it “gets a lot of press,” Zuschin said. However, the benefits of this can be limited. The big falls in stocks last March created big losses, but any investors who “harvested” a tax loss would have had to scramble to unwind it when the market rebounded sharply, he said.

In general, an investor’s entire holdings should be pointing in the same direction in terms of asset allocation and risk management, Zuschin added.

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