Given the run-up in stock prices over the past several years, many advisors have struggled with how they can reduce their clients’ equity exposure on assets outside of retirement plans while minimizing the tax impact typically triggered by these portfolio reallocations. Common strategies include tax-loss harvesting, making a charitable donation using appreciated stock, and a more complex strategy of using options to build an insurance overlay on the portfolio.
All of these strategies have one thing in common, though. They are attempting to solve a problem rather than avoiding it in the first place. Wouldn’t it be nice if there were a way to regularly rebalance a portfolio of stocks and bonds with minimal tax impact to keep the portfolio in line with the client’s risk tolerance?
Alternative Tactic: A Variable Annuity
Depending on the client’s circumstance, a variable annuity could be a viable solution.
Somewhere along the way, the financial industry began to think a variable annuity always had to be sold with a living benefit as a means to lock in a predetermined amount of retirement income. We seem to have forgotten that a variable annuity can be a great way to shelter portfolio gains from income taxes. Any decent variable annuity today will have a multitude of investment selections allowing clients to invest in domestic and foreign stock, fixed income funds, commodities, etc. Just as important, if you need to rebalance your clients’ portfolios — either because a client’s risk tolerance changes or the markets change — as long as the money stays in the annuity, any gains continue to be tax-deferred.
A Client Case Study
Let’s say that an advisor has a 70-year-old client who holds the majority of his assets with a non-qualified trust account. His previous advisor recommended the cookie cutter 40/60 portfolio expected for a client his age. Between his pension and Social Security, though, income is not a need for him. After reevaluating his objectives and risk tolerance, he and his current advisor agreed he could benefit from more equity exposure. However, his pensions, Social Security and investment income already were creating a fair amount of taxes for him, and they needed a solution that would not substantially add to his tax burden.