More About Death and Taxes

Clients are doomed to pay more taxes. They need our help

July 8th, 2018

By  Steve Gresham


Taxes matter. A lot.

Recent research by 1st Global places tax knowledge at the top of a list of important factors that clients consider when selecting a financial adviser. Taxes are the biggest expense paid over their lifetime by most investors, and the best advisers are all over it. 


But big chunks of the advice industry are not helping clients plan for the impact of taxes. The reasons include understandable issues of expertise and at-scale compliance, but to many clients that just makes no sense.

According to a Hearts and Wallets study, 89% of investors think they are getting help in reducing tax costs or would like to get help. Enough already. It's the biggest expense, customers expect or want it, and it's high on their list of how they choose an adviser — we have to do more than talk about taxes, we have to do something about them.

There are leaders in this arena among advisers and advisory firms. The June 18 edition of InvestmentNews features a story about Morgan Stanley making a big tech bet to capture $2 trillion in clients' assets that are held away from the firm, and that bet includes better tax advice. 

That's the game today — consolidating assets of existing wealth management clients and driving referrals off that consolidation. The typical wealth management client today has assets in three to five different accounts, and history indicates the client will trim that list. There will be winners and losers as the boomers age, and my guess is that providing true tax efficiency for clients will be a winning strategy.

To be at good working with clients to reduce taxes, you need both technical expertise and the ability to manage client emotions. You also need tools — like the ones leading advisers have deployed.

The best advisers I know deconstruct "taxes" into distinct solutions that together add up to significant value. I don't have the space here to give justice to the topic, but I'll hit the high points of tax efficiency — behavior management, tax-efficient investing, asset location across multiple account registrations and the optimal sequencing of withdrawals.

The first step is the client behavioral management around taxes. Taxes make some people really crazy — and crazy people can make bad decisions. After nine years of a bull market, I'm thinking that there is more than one investor who ought to take some chips off the table — but how many will balk at the tax bill?


Behavioral management is the highest value-add of a great adviser, and you sure do earn that value around taxes! Only when you and your client agree on a philosophical view of taxes can you move on to the scientific stuff. 

The science begins with tax-efficient portfolio management but quickly reveals the importance of asset location. Asset allocation is about managing risk. Asset location is about managing taxes. One Morningstar study says the advantage of managing risk averages 0.38% per year. 

Asset location is about locating tax-efficient assets in taxable accounts and tax-inefficient assets in qualified accounts. This is where those multiple custodial relationships create opportunity for the tax-savvy adviser. The typical wealth management client is really a household made up of two to three generations and many different accounts. Only rarely are these disparate parts designed to fit together. 

Most clients buy stuff at different times from different firms for different reasons. Making sense of this hodgepodge is a real undertaking, and helping clients get organized is to me the next most important role of an adviser after behavior management. 

But to do asset location well, you have to have the tools to effectively and accurately analyze the multiple client accounts across custodians. A lot of advisers simply lack the digital capability, and doing the work manually is a huge time drag. Asset location can significantly improve tax efficiency but it requires an investment in systems capable of supporting the effort as well as the commitment to capture all the necessary data. 

The tools are out there — and the leaders are using them. The payoff is big, but so is the effort. It's no coincidence that when the going gets tough here, we see the adviser leaders begin to pull away. This is also the spot where we lose virtually all the robos, whose tools are typically limited to each individual account and don't support a household solution. If it's done right, the Morningstar survey calculates the annual benefit of asset location at 0.52%.

Last of all — but typically most important to clients — is the sequence of account withdrawals. The baby boomers have increased the complexity of this activity with an array of account types, including taxable accounts, multiple IRAs, 401(k)s, annuities and pension benefits. Throw in Social Security and required minimum distributions, and the average retiree (and adviser) is overwhelmed. 

One advice firm's survey of high-net-worth clients revealed that clients regarded advice about how and when to best withdraw assets from their accounts as more important than any other planning service. The Morningstar survey places the annual value of optimized withdrawals highest among the components of tax efficiency, at 0.54%. 

Optimizing account withdrawals across a number of different client households requires a lot of effort and the right digital toolbox to crunch the numbers and maintain a dynamic view over time. Jack Sharry of LifeYield lists four components of optimal withdrawals sequencing — Social Security benefits, the timing of Roth IRA conversions, a schedule of tax-optimized withdrawals across taxable, tax-deferred and tax-free accounts, and a strategic approach to maximizing income based on the other three elements and factoring in multiple accounts and products.

There are a lot of moving parts and too many investors and their advisers default to the required minimum distribution as guidance for timing and account selection — to the detriment of their clients. We can do better. And since the software exists to make it work, why aren't we doing better?

Finishing where I began, please consider Death and Taxes for your marketing plan. The name of the game today is beating your competition and earning the consolidation of assets and client referrals. Make tax-smart household management part of your strategy. When you are good at something clients want and your competition doesn't play, you win and your clients win. 

If you've been tallying the Morningstar math along the way in this column, the advantages of a tax-efficient approach can be 1% to 2% per year. With a future that may see lower average returns, that is a powerful advantage for your practice.

If you've been tallying the Morningstar math along the way in this column, the advantages of a tax-efficient approach can be 1% to 2% per year. With a future that may see lower average returns, that is a powerful advantage for your practice.