Deploying tax-efficient strategies within an investment portfolio is one of the most critical roles of a financial advisor, especially because many investment managers focus on pretax investment returns. By emphasizing after-tax returns, advisors may better meet the needs of their high-net-worth clients—particularly in high-tax states.
Here are three key areas to focus on to improve after-tax returns:
Think asset location.
Not to be confused with asset allocation, asset location is one of the most effective tactics in maximizing after-tax gains. This means tax-inefficient assets—corporate bonds, private debt, high-turnover strategies—belong in tax-deferred or tax-exempt accounts, compounding tax-free.
For taxable accounts, prioritize tax-efficient options such as low-turnover stock strategies, direct index solutions, low-dividend growth equities, municipal bonds, or preferreds with qualified dividends. Let compounding work its magic in a tax-efficient way. Growth assets should be allocated to accounts for future generations, while income-oriented assets belong in accounts with shorter time horizons.
Emphasize long-term capital gains.
Sometimes the best strategy is patience. Despite the potential for tax law changes ahead, time-tested tax-efficiency strategies will continue to reward high-net-worth families.
The longer assets are held, the more returns compound with minimal tax drag. Let time be your ally and factor in the long-term capital gains advantage. Over time, the difference between realizing or deferring long-term capital gains and avoiding higher short-term capital-gains tax rates will lead to better after-tax results.
Plan ahead for 2025.
Truly strategic planners are already looking ahead to 2025 and beyond when there may be a crucial shift in the lifetime exemption from estate taxes.
The current $13.61 million per person exemption is slated to be effectively cut in half, aligning itself with pre-2017 Tax Cuts and Jobs Act levels (adjusted for inflation) if Congress doesn’t act. The situation facing advisors and clients is similar to that of 2012 when gift tax exemption provisions were set to expire at the end of that year. Proactive measures, including early collaboration with estate planning attorneys, will ensure well-considered decisions and prevent last-minute decisions made under pressure.
Incorporating tax sensitivity into everyday portfolio management, along with proactive planning for potential tax law changes, strengthens the compounding power of client portfolios.
The ever-growing U.S. budget deficit increases the likelihood of tax changes, potentially including a decrease in the estate tax exemption and a rise in the tax rate. By focusing on these three key areas of tax efficiency, advisors can empower their clients to navigate these changes effectively and achieve superior after-tax returns.
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Written by Caleb Silsby, Executive Vice President, Chief Portfolio Manager at Whittier Trust. For more information, start a conversation with a Whittier Trust advisor today by visiting our contact page.
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