The bespoke approach – taking tax-management to the next level

For many clients, offering a standardized approach to tax-management – such as investing in municipal bonds/funds instead of corporate bonds and using tax-managed funds for equities in non-qualified accounts – can be sufficient to help meet the client’s desired after-tax wealth creation outcome. In fact, depending on the client’s situation, it could be the most optimal approach, once the related costs and benefits of such programs are taken into account. But for certain clients, a more bespoke approach to tax-management may be warranted. Think, for instance, of those clients who are especially tax-sensitive or those with sizeable qualified and non-qualified accounts. The approach you may want to consider in these sorts of cases is called “asset location.”

The “asset location” approach to tax-management

At a high-level, this approach guides financial advisors to more specifically evaluate the relative tax implications of placing certain assets/asset classes in qualified versus non-qualified accounts. Generally speaking,

• assets that tend to be more tax-efficient and/or can be managed to help minimize tax costs should be used in non-qualified accounts;
• assets that aren’t typically tax-efficient (or that could lose a meaningful amount of value to taxes) should be used primarily in qualified accounts.

For example, when looking at a fixed income portfolio, both tax-exempt bond portfolios (muni bonds) and corporate and high yield debt can be valuable in a client’s portfolio. But if they are in the “wrong” type of accounts, their effectiveness may be reduced. To do asset location correctly, you need to see and understand all of the client’s assets – whether they are currently located in qualified or non-qualified accounts – and even assets beyond traditional investment accounts. For instance, consider a client who owns real estate. Depending on the type of real estate they own, a REITs (Real Estate Investment Trust) portfolio may be redundant and could increase the client’s overall investment risk rather than reducing it through appropriate diversification. Further, if the client’s real estate investments generate income, it could also have implications for the fixed income portion of the client’s portfolio.

A potential growth tool for you

The potential benefit to clients of such hands-on oversight and bespoke solutions that take into account their total investment portfolio are clear. These clients are likely to recognize and appreciate the care you put into developing a deep understanding of their entire financial picture and formulating a financial plan and solution set designed to meet their unique goals. And for advisors, the approach can help uncover hidden assets – those assets your client may have declined to disclose to you – and potentially increase your key clients’ loyalty to you, helping you grow your business in the areas where you can add the most value. So, don’t shy away from these client situations. Instead, relish them for the challenge and growth opportunity they can represent.