T is for tax-smart planning and investing

This is the fifth and last blog in a five-part series, discussing why Russell Investments believes in the value of advisors, based on this easy-to-remember formula:

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value of advisor calculation

In this section, we’re talking about T, which stands for tax-efficient planning and investing. Because it’s not about what the investors make. It’s about what they keep.

In 2018, 91% of all Canadian equity funds had a negative return. 58% of all Canadian equity funds had a capital gain distribution. And the average capital gain distribution from Canadian equity funds in 2018 was 3.5%.* For advisors who are smart about taxes, incorporating tax management is a tremendous opportunity to help their clients keep more of what they earned. 

There is a myriad of tax implications in investing: asset allocation to registered and non-registered accounts, tax-smart withdrawal strategies, taxable trusts, corporate class funds and so on. Taking a tax-efficient approach to investing by using strategies that are designed to help reduce the impact of taxes on investment returns may help you achieve better outcomes. As you can see in the chart below, there are significant differences in taxation depending on the type of distribution an investor receives. 

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difference in taxation fo 1000 of distributions

Structuring an investment portfolio so that distributions are made in the form of Return of Capital rather than capital gains can help lower the taxes that would have to be immediately paid. We call that difference in taxation the "tax drag" on an investment. 

Let’s look at how reducing the tax burden on your portfolio can help improve the outcome.  Check out the value of the T on a hypothetical $500,000 proposal projected out 10 years, with annualized growth of 7.5%. With no tax drag, the end value is projected at just more than $1 million. Using tax strategies to reduce taxes by 1% on the total portfolio, the hypothetical end value is nearly a million--$939,000. But with a tax drag of 2%, the end value is only $854,000. In this illustration, the hypothetical value of T over 10 years is $177,000.

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Put the math in your favor


Now let’s look out even further. Over 20 years, with the same proposal and the same assumptions, the ending dollar difference—the value of T—is $665,000. 

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hypo growth of 500k over 20 years at 7.5 percent per year

Taxes matter. And this is a massive area for advisors to deliver value to their clients. So how are you elevating your value? How are you, as an advisor who incorporates tax management, talking about this with your different clients? For clients who might benefit, advisors should be considering the following questions when managing for taxes:

  • Do you KNOW each client’s marginal tax rate?
  • Do you PROVIDE intentionally different investment solutions for registered and non-registered accounts?
  • Do you EXPLAIN to clients the benefit of managing taxes?
  • Do you HAVE a process for partnering with local CPAs (Chartered Professional Accountants)?
  • Do you REVIEW your client’s tax returns?

Doing a forensic review of your client’s tax returns can be really eye opening. Looking at the list of potential deductions really connects the dots between what a client makes and what a client actually keeps. And the tax process sometimes buries that a little bit. Clients don’t necessarily connect what they are paying with what they are investing. This is an opportunity for advisors to shine. Simply walking through the different tax strategies available and discussing insights, implications, and income impact for clients can be truly beneficial. On their own, clients are unlikely to connect the dots between dividend distribution impact on their total wealth return. You, the advisor, can reveal what they may be sacrificing to taxes. And better yet, you can do something about it. A tax-managed approach may help you provide a significant reduction in the tax burden between one year and the next.

Communicate your value

This is the final section of our 2019 value of advisors series. But all this demonstrated value that we’ve discussed in this blog post, in the series, and in the full report, can go unnoticed by your clients without one vital action on your part: communication.

Advisors need to communicate the value they provide to their investor clients. We have found that the quality of an advisor’s communication would benefit from greater effort and greater intentionality. After all, your value is only as good as the client experience that you are reliably delivering, clearly communicating, and constantly elevating.

So then, what are you going to do to elevate your value? We believe a tax-smart approach might be your best place to start.

* Canadian equity funds: Morningstar broad category ‘Canadian Equity’ which includes mutual funds. Average Canadian equity fund Distribution: Capital Gains/Share (% of NAV) based on Morningstar Canadian Mutual Funds (Series F only). % = 2018 Calendar Year Cap Gain Distributions / Latest Capital Gain NAV. Distribution is assumed to be made at last day of year and reinvested.
NAV=Net Asset Value