Wealthy Clients’ New Demand for Advisors: Reduce Their Tax Bill

These figures suggest that many clients with significant assets aren’t getting the full suite of services they now expect, Cerulli warns, and that could put advisors’ business success in jeopardy.

To meet this demand, advisors are leveraging investment tax management capabilities made available by their firms or their asset manager and technology provider partners. Many firm leaders now prioritize improving their tax capabilities, according to the report, although some firms still seem to be lagging behind.

Critical Investment

Cerulli’s Scott Smith told ThinkAdvisor that savvy advisor firms across the spectrum are pouring resources and expertise into process and product improvements to help meet the demand for higher after-tax returns. Some are doing it better than others, he noted, but no single solution is going to fit across the entire industry.

Relatively few firms have made significant progress in creating a comprehensive platform of tax management processes and products, Smith said. Many have incorporated limited tax-management capabilities, such as adding direct-indexing capabilities into their model portfolio management process.

These one-off solutions can be hard to scale, Smith warned, and they will likely not deliver the 200 to 300 basis points in additional annual performance that Cerulli believes is possible through a comprehensive approach. Those furthest along appear to be the largest broker-dealers that fit into Cerulli’s “enterprise scale” firm category. These firms have managed assets in excess of $1 trillion and have built or acquired proprietary process solutions they are seeking to complement with proprietary and non-proprietary products.

Outside the largest firms, Smith observed, the “emerging enterprise” and “growth-oriented boutique” categories are realizing that they will need to either partner or fully outsource to get access to the most comprehensive tax capabilities.

As Smith emphasized, in addition to accessing best-in-class technology and investment products, firms considering partners or outsourced capabilities must address connectivity and data integration. Also important is ease of use and the quality of client service, among other factors.

Areas of Focus

Achieving a comprehensive approach to tax management, as Smith detailed, requires support for the full client lifecycle, from initial onboarding to efficient income and legacy planning.

For example, Smith noted, a new client’s current asset holdings and allocations rarely match an advisor’s recommended portfolio. Yet moving to a new portfolio requires selling assets at various degrees of gains and losses. For that reason, the onboarding and ensuing transformation of the portfolio is a crucial element in achieving tax efficiency.

“Implementing a portfolio that addresses annual tax liability budgeting, concentrated position risks and allocating investments at the household level is an extremely complex exercise that exceeds the current capabilities of most wealth management platforms,” Smith warned. “It's hard, but it is vital to truly optimizing clients’ net financial benefits.”

Asset location analysis is another critical area of focus, according to the report. For example, a household at the top marginal tax rate of 37% would pay that rate on ordinary income, including bond dividends and tax-deferred retirement plan distributions. On the other hand, they will face only a 20% capital gains rate on securities held for more than a year in a taxable account. By strategically putting asset classes with different return expectations and holding periods in the appropriate vehicle, Smith said, substantial savings are possible.

Yet another step in constructing an initial portfolio onboarding transformation strategy is determining the client’s preferred timeline for execution, Smith said. Any transition is likely to create current taxation as appreciated securities are replaced, but many clients would prefer that this impact be felt over time to allow for dispersion of tax liability and the potential generation of offsetting capital losses.

Based on expressed client preferences, Smith said, wealth managers need to prioritize their recommendations with an order of operations that provides maximum short-term improvement with minimal tracking error, bound by the limitation of clients’ annual tax budgets.

Once clients are transitioned to a new portfolio, ongoing tax management capabilities can continue to deliver added value. Key areas of consideration include active tax-loss harvesting powered by direct indexing, tax savings reporting, retirement distribution optimization, wealth transfer strategies, charitable giving and efficient Social Security claiming.

Bottom Line

What’s clear about these tax management techniques and how firms can improve their processes and product sets, according to the report, is that wealthy investors are increasingly expecting a customized experience. Related, they care deeply about mitigating the impact of taxes on their wealth accumulation and decumulation goals.

To address that, Smith said, advisors are seeking to differentiate themselves by offering engaging tax management capabilities.

“For all but the biggest enterprises out there, getting the marriage of internal and external capabilities correct is crucial,” Smith concluded. “Successful firms will focus on not just quality technology capabilities, but also integration, ease of use and client service elements.”