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4 Smart Portfolio Tax Strategies

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SAN DIEGO -- Want a way to save your clients money, demonstrate your value and stand out from the robos?

Minimize your clients' tax bill, says Sheryl Rowling, CEO of Total Rebalance Expert and the principal of planning firm Rowling & Associates in San Diego.

"Robo advisors out there are pushing the fact that 'we harvest tax losses'; you have to offer this to compete with them, but you're going to go farther than they do," Rowling told planners at the annual NAPFA conference here this week.

Rowling laid out four ways advisors can help clients cut their taxes -- and in doing so, stand out from the robo competition that promotes their own tax-efficient investing strategies.

1. Harvest tax losses. "Harvesting throughout the year is a key differentiator," says Rowling -- whose company, TRX, provides automated rebalancing software for advisors.) 

When rebalancing, advisors should be careful in selecting a replacement fund. "If you can't find a suitable replacement fund, don't do the tax-loss harvesting, because then you're not sticking to your investment strategy," Rowling says.

In setting up parameters for when to sell a position, planners should consider both percentage loss and the dollar amount. "Obviously, you do not want to harvest losses that aren't worthwhile," Rowling notes. "It has to be a material amount, but it also has to be a decent percentage amount." Her rule of thumb for the percentage of losses is around 10%.

But within this strategy, planners should avoid wash sales -- buying back the same stock or fund (or one that is substantially identical) within 30 days -- which can happen if you're not careful, she says.

2. Use high-cost lots. When rebalancing, advisors should sell the highest-cost lot to minimize capital gains taxes. "Many advisors have been using average cost or first in, first out," Rowling says, but that means clients could be paying more on capital gains. 

With custodians, highest-cost is not the default election for selling a lot, so advisors need to tell specify which position they want to sell. "You would be amazed at how many advisors don't make that election," Rowling says. "It's a very easy way to save your clients more money without doing more work."

3. Optimize asset location. With this strategy, planners place investments in accounts based on their tax characteristics. 

Tax-inefficient investments such as fixed income go into IRAs and other tax-deferred accounts. When fixed income has to go into a taxable account, Rowling says, advisors should use munis. Appreciating assets go in taxable accounts, and investments with high volatility are held in Roth IRAs.

"Location optimization gives you an opportunity for permanent tax savings -- and that's the Holy Grail for managing investments for tax minimization," Rowling says.

But advisors should also note that they will need to educate clients about such a strategy that can at times seem counterintuitive. (Consider how clients might feel about an IRA composed of bonds that is not growing very fast and they are beginning to take required distributions.) "You have to train clients not to look at each account," Rowling says. "Report to them on a portfolio basis, not an account basis."

4. Avoid short-term gains. If selling a position that a client hasn't held for more than 12 months results in a gain, that client will pay taxes at the ordinary income rate. Instead, wait to sell and convert those short-term gains to long-term gains in order to get permanent tax savings for clients. "It's worth it to bend the allocation a bit to get that tax benefit," Rowling says.


Using these strategies to reduce taxes, advisors can keep more money in clients' pockets and demonstrate the value they offer, thus retain more clients and close on new prospects, Rowling argues. "The biggest reason to do it is that it gives you a competitive edge," she says.

Clients may not fully understand the intricacies of these practices, but they will appreciate the benefits and the value their advisor provides -- especially if advisors can quantify it by comparing tax returns.

"People are really, really bothered by taxes," Rowling says. It's a winning strategy, she says, "if you can show them, 'Hey your money is going to work hard for you, but we're going to save money for you, too.'"

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