Tax harvesting and asset location are terms associated with the mitigation, even prevention, of certain tax costs for investors. This article talks to practitioners.
There is more to a bountiful harvest than a ripening field of wheat or grape collecting in a vineyard.
The term “harvest” also has taken on significance in the wealth management industry when it comes to investors seeking to make the most of the ability to set losses in a portfolio against potential tax gains, using state-of-the-art technology to manage variations rapidly. With the US tax-filing season reaching its annual, white-knuckle crescendo (deadline is April 18), a need to understand how to mitigate the impact of taxes on investments is at the forefront of investors’ minds. And this is particularly acute given the arrival of a new administration in the White House with its promises about reducing taxes.
By selectively selling specific investments, advisors can realize gains or losses in an account. Selling investments in a client's taxable portfolio that have dropped in value – i.e., “harvesting” those losses – will generate losses that can be used to offset gains the client’s portfolio has realized. Alternatively, advisors can help clients realize gains in their taxable portfolios to offset losses from other investments. Especially during volatile markets, tax harvesting can provide an effective way to use losses to enhance after-tax portfolio performance.
A practitioner in this space is Trust Company of America, based in Colorado. TCA recently launched a tax harvesting feature on its account management platform to help financial advisors manage the tax impact of capital gains on clients’ portfolios with no additional cost or paperwork.
Besides the harvesting of losses to achieve lower tax, another route of tax-efficient investing is to hold certain types of investment in low-cost investment-only variable annuities that are tax-deferred. For such annuities, which are provided by firms such as Jefferson National (based in Kentucky), an investor will put assets into the annuity that are seen as relatively inefficient from a tax viewpoint, such as Real Estate Investment Trusts and forms of fixed-income investments.
This sort of approach is known sometimes as “asset location,” of putting certain asset types in a tax-deferred vehicle to mitigate clients’ tax while retaining the same overall “asset allocation”, Lindsay Faussone, vice president of business development at TCA, told Family Wealth Report in a call.
“With investments, you have to look at the tax erosion impact as well as at fees,” Faussone said.
Tax harvesting and asset location approaches stem from the same challenge of reducing the drag on investment performance from tax, she continued. “I look at asset location as a way of preventing tax, and tax harvesting as a way of minimizing tax impact,” Faussone continued.
Her firm, a platform and custodian for fee-based advisors, does not provide proprietary products– there is no conflict of interest as far as clients are concerned in such cases, she said. Such activity is a classic example of advisors doing their best for clients, she said.
The recent election, whatever else it did, has put tax on the agenda, and given a fresh edge to the need for nimble tax harvesting, argues JC Abusaid, president and chief operating officer of Halbert Hargrove, which is headquartered in Southern California. (That firm has offices in San Diego, Washington State, Denver, Texas and Arizona. The firm is fee-only, charging one percent of AuM starting at $1 million, and lower charges on larger amounts.)
“We’ve been very careful right from the outset of the [presidential] campaign to state that we are highly active on the tax impact on clients. So today we are not doing anything differently,” he said. “We’re hypervigilant,” he continued.
“I think tax harvesting is under-appreciated,” he said.
Abusaid said his firm has always been proactive about the impact of tax on portfolios, with the harvesting of losses a daily, relentless process rather than something undertaken once every six months or at the end of a financial year.
And in sometimes volatile markets where there are dislocations and rapid changes, the potential to use the tax harvesting technique is wide, Abusaid continued.