Tax management is an oft-overlooked element of an adviser’s value proposition, but that doesn’t make it any less important. Fluid tax laws mean its significance won’t be diminishing any time soon.
In an interview with InvestmentNews Content Strategy Studio, Bob Breshock, the managing director leading Parametric’s family office advisory group, discussed some of the potential tax changes on the horizon that could affect advisers and their high-net-worth clients. He also shared how advisers can demonstrate the value they bring to clients with efficient tax management. A synopsis of the interview follows:
InvestmentNews Content Strategy Studio: What are some of the potential tax changes we could see under a Biden administration that would impact high-net-worth investors most?
Bob Breshock: With the Democrats winning both Georgia Senate seats they get to a 50-50 split in the Senate and President Biden could pass his vision of tax reform without a single vote from a Republican. This is made possible by “Budget Reconciliation,” a streamlined process for passing revenue or spending bills. As part of the process, when a bill gets to the Senate, instead of needing the standard 60 votes for passage, it instead requires only a simple majority. (In the event of a 50-50 tie, Vice President Kamala Harris would cast the tie-breaking vote.)
It’s worth noting, however, the timing of tax reform may need to coincide with a post pandemic economy that would be less jeopardized by tax hikes. That said, one item that could have a potentially large impact on high-net-worth investors: For households with adjusted gross income (AGI) of more than $1 million, Biden has proposed taxing realized gains and qualified dividends at regular income rates, instead of the lower capital gains rate that exists today.
Some of Biden’s other proposals could affect estate planning. Currently, the Federal Gift and Estate tax exemption is poised to be reduced from $11.58 million to $5.85 million at the end of 2025. Biden has proposed a return to 2009 levels, which stood at $3.5 million for estate transfers and $1 million for gifts, with an increased maximum tax rate of 45%. Essentially, more people would be subject to the estate tax, and at a higher rate. He has also proposed eliminating the step-up in cost basis for an inherited investment.
InvestmentNews Content Strategy Studio: What should advisers do in consideration of these potential changes?
Bob Breshock: It will be different for each client, but advisers will have to evaluate the tradeoff between accelerating the realization of capital gains before the potential tax increase – and giving up deferment, vs. paying capital gains at a later point in time with a potentially higher tax rate. They’ll have to factor in the time horizon of the investment, the market environment they anticipate, the tax rate and of course the risk of continuing to maintain those investments.
The murkiness of each of those factors underscores the benefit of having your clients in separately managed accounts. It gives the adviser a level of control that you just don’t have with an ETF or mutual fund, where the behavior of other investors in the mutual fund can force taxes on you as they redeem shares based on their own decisions. In this environment, where there’s a number of unknowns, controlling what you can and having that ownership of the realization event and the tax lot is going to be extremely important.
InvestmentNews Content Strategy Studio: Circling back to the potential tax changes that could affect estate planning, is there any specific advice for to prepare for that potential change?
Bob Breshock: Many high-net-worth individuals will need to consider using some or all of their current high exemption amount before it is potentially lost. For advisers, this will require careful analysis of how much to give away now and how much to retain for other needs and goals. Advisers will likely consider more use of various split interest trusts such as grantor retained annuity trusts (GRATS). Also, the potential loss of basis step-up means advisers should evaluate charitable giving for highly appreciated assets as well as assessing the investment risk versus tax deferral benefit of low basis holdings.
InvestmentNews Content Strategy Studio: Tax advantaged investing is one of the adviser value adds that clients may not fully appreciate. How can advisers raise awareness?
Bob Breshock: When you think of the built-in frictions that chip away at someone’s wealth – an adviser fee, potentially a commission, the investment manager fee and then taxes … Taxes are by far the single largest. Luckily, there’s been a real improvement from a variety of platforms that highlight the corrosive effects of tax drag. That modeling can really help advisers quantify their value add and show how they are increasing the client’s wealth by effectively managing taxes.
As an adviser, it can also help to sit down and show your clients some of the modeling and scenario analyses you are conducting to consider tax implications. The client experience is changing in that it’s much more of a partnership. More and more high-net-worth investors want some control and involvement in the decision-making process. If you can show them you’re setting the framework in the right way, but giving them a hand in making decisions, you’re improving their experience and at the same time demonstrating some of the work and planning that goes into tax-advantaged investing.
InvestmentNews Content Strategy Studio: What tax laws may be coming off the books in the next five to 10 years that advisers should prepare their clients for now?
Bob Breshock: In 2025, many of the provisions of the 2017 Tax Cut and Jobs Act will sunset. Tax rates will change, standard deduction changes, the limits on state tax deductions and mortgages change, the reduction of AMT will change. It points to the ongoing fluidity of the tax environment. There are a lot of changes on the horizon and continued vigilance of taxes will be needed. For advisers who haven’t emphasized tax management, this is a strong way to link to your clients, show your value and create a sticky relationship.
InvestmentNews Content Strategy Studio: What is Parametric doing to help advisers further their tax advantaged investment efforts?
Bob Breshock: Advisers and clients want more and more customization of individual portfolios. We’re constantly innovating and providing new tools for advisers to assess the tradeoffs in building these customized portfolios so they have a sense of how that portfolio will perform relative to an index. As just one example, if an adviser has a client that wants to take carbon out of his or her portfolio, our tools can help them know what to remove, and go a step deeper and show the implications of those changes relative to a non-carbon screened benchmark.
There are always tradeoffs and frictions in customization. We help advisers and clients understand and manage those tradeoffs in risk, taxes and cost.
The post Talking Taxes: Parametric Discusses Tax Changes, and How Advisers Can Demonstrate Their Value Add appeared first on InvestmentNews.
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