Dispatches from the Tax-Efficient Frontier

Schreiner takes an active approach, which will generate some short-term capital gains for clients, but as he says, “If we can manage risk and preserve capital, for risk-averse investors, the tax bill is secondary.” Still, there’s no doubt that minimizing taxes on tactical strategies can bring greater benefit to clients and enhance their portfolio’s performance. That’s when the Tax-Efficient Frontier comes into play. Research confirms that tax-inefficient assets such as actively managed investments that generate short-term capital gains consistently perform better in a tax-deferred vehicle.

But Schreiner has always found tax-deferral options limited, especially for his high-net-worth clients. “Once an investor maxes out their 401(k), IRA and Roth, if they still have long-term funds to invest, there aren’t many advantageous solutions.” Schreiner believes these are the ideal clients for using a low-cost, no-load variable annuity to achieve the Tax-Efficient Frontier. “They appreciate the benefits of tax deferral—and the substantial savings in fees. They don’t need riders—they need the tax shelter. They want their income to compound and grow.”

Benefits for Bonds
When it comes to helping clients maximize returns to generate 30 or more years worth of retirement income, many advisors seek solutions to beat the market with minimal risk. Lexington, Mass.-based BTS Asset Management, an RIA with nearly $2 billion in assets under management, over 15,000 individual and corporate accounts, and partnerships with more than 3,000 financial planners nationwide, has been providing such solutions for clients and for other advisors since launching in 1979.

There’s a credibility earned by being one of the oldest third-party money managers in the industry. “With three decades of experience, we’ve been through a lot of different markets and economic situations—bull and bear, recession and recovery,” says Isaac Braley, president of BTS. “We do it using bonds—and that does not receive any special tax treatment. Our portfolios are tactical—meaning 100% of returns most likely are going to be taxed at ordinary income. So, a tax-deferred compounding vehicle is an unbelievable tool for us,” says Braley.

From Braley’s perspective, The Tax-Efficient Frontier is the right fit for BTS’ fixed income strategy. “We have historically outperformed the market and have demonstrated the potential to enhance returns. And when we can use a tax-deferred vehicle to wrap it up, let the gains grow and only pay taxes on the money when clients need it, it enhances the performance potential in a meaningful way,” Braley says.

A Simple—but Effective—Strategy
Do clients understand the intricacies of the Tax-Efficient Frontier? Not always. But there are simple steps you can take to help guide them through the asset location decision. It can be useful to maintain a grid where all of the available asset classes are arranged in order, by tax efficiency and potential return based on time horizon, so clients can clearly see when and where tax-deferral can offer the greatest benefits. It is also helpful to review clients’ holdings in their taxable and tax-deferred accounts. If the allocations and underlying holdings are essentially mirror images of each other—rather than being located based on tax-efficiency—your client may be missing an opportunity to improve performance without any increase in risk.

Of course, an asset location strategy only makes sense with clients who have both taxable and tax-exempt assets. If clients have everything in a tax-deferred account, the asset location question is moot. But once you start to have a relatively good mix between taxable and tax-deferred vehicles—at least 80-20 one way or the other—that’s when clients start to see the real benefits of the Tax-Efficient Frontier.

Trends clearly indicate that there will be a greater demand for a holistic approach to financial advice—and with that will come a greater tax awareness added to portfolio construction. Using tax-deferral strategies to unlock the potential for greater performance can help clients complete their long-term investing strategy and reach their goals faster. In an environment like today’s, where every single basis point of performance counts, tax deferral will rise in importance and the Tax-Efficient Frontier will emerge as an important new financial landmark.    

David Lau is chief operating officer of Jefferson National, innovators of the first flat-insurance fee variable annuity with the industry’s largest supermarket of tax-deferred funds. He is also author of recently published white paper “The Tax-Efficient Frontier: Improving the Efficient Frontier with the Power of Tax Deferral.” To download a copy of his latest research, visit www.jeffnat.com/thefrontier. For more information, call 1-866-WHY-FLAT (866-949-3528).