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Multi-Account Asset Location is Easier Than You Think

October 28, 2021 Steve Zuschin By Steve Zuschin

A long-term study by the U.S. Bureau of Labor Statistics confirmed what financial advisors have observed: People born between 1957 and 1964, the latter years of the baby boom, have had many jobs in their careers. Many, many jobs.

On average, respondents to the survey had more than 12 jobs between ages 18 and 54, the BLS reported recently. While the length of time people stayed in jobs lengthened after age 24, many still had several jobs of short duration even in their 30s and 40s.

Now, think of the two-income households you work with – and how many jobs two wage earners may have had. You can quickly imagine the number of multiple accounts you’re being asked to harmonize. Imagine all the potential 401(k), pension plans, individual retirement accounts (IRAs), and broker accounts these households may have!

How do you approach that tower of investments? One of the first places you start is with the process of asset location to reduce one – and often THE largest expense – of most households in retirement – taxes.

Once a daunting task, asset location is easier to accomplish today with technology. LifeYield Asset Location is already available to many financial advisors through their own firms’ technology for client account management. And LifeYield makes multi-account asset location easier than you think.

Why Focus on Asset Location?

When clients are climbing career ladders and investing for the future, they seldom focus on their tax liabilities as much as they do on their potential returns.  But they will pay taxes from their earning years through their retirement years. Wouldn’t you like to have an easier way to convince them to pay attention to asset location and tax efficiency?

Frankly, it’s easier to do that when you can show them the net effect in dollars they’ll pay in taxes. That’s where LifeYield Asset Location makes it easier for financial advisors to win clients’ confidence and accumulate more assets under management for their firms.

What Is Asset Location?

It sounds like, but it’s different than, asset allocation. You need to work to educate clients about both asset allocation and asset location – and the strategy behind each of these.

Allocation describes the process of distributing investments in a portfolio among asset classes in the attempt to reduce the risk and enhance the rewards. Asset allocation requires understanding each client household’s risk tolerance, financial goals, and timelines (or investment periods).

Asset location is about placing investments into the most tax-efficient accounts that they can be in. Nobody wants to pay more for taxes than they must. A strong asset location strategy can reduce the amount of taxes investors pay on their investments and increase the amounts that the clients take away in income.

The Point of an Asset Location Strategy

Coming up with a tax-efficient asset location strategy for a client can do a lot for their overall portfolio. When you actively work on this type of strategy, you are helping with:

It isn’t about sheltering assets and accounts from taxes. It’s about understanding and communicating what clients should know to be sure they’re making the most of opportunities for saving on taxes while investing. And if clients might need to access one or more of their accounts for larger purchases (before retirement), having the assets appropriately located will mean they pay only the taxes they are legally obligated to pay.

So, what can you do about this?

Types of Investment Accounts

Investment accounts are either taxable or tax-advantaged. To break this down even further, there are accounts that are taxable at regular tax rates, tax-deferred accounts, and even tax-exempt accounts. Financial advisors help clients make the most of the opportunities available through each type of account to achieve the most in their overall portfolio.

Taxable Accounts

Taxable accounts are accounts like traditional brokerage accounts that hold securities like stocks, bonds, exchange-traded funds (ETFs), real estate investment trusts (REITs) mutual funds, and more. Owners of these accounts pay taxes when the investments earn dividends or interest or when sales of investments that have gone up in value lead to capital gains.

Tax-Deferred Accounts

Accounts that are tax-deferred allow for payment of taxes to be delayed until the money from the investments is withdrawn. Most of the tax-deferred accounts you see are 401(k)s and individual retirement accounts (IRAs). When investors withdraw funds from tax-deferred accounts, they pay ordinary income tax rates, which will vary depending on their tax bracket. 

Tax-Exempt Accounts

Examples of tax-exempt accounts are Roth IRAs and Roth 401(k)s. Investors in these accounts pay income taxes upfront but, if they follow the rules for the accounts, they don’t pay taxes on any gains in the accounts. Health savings accounts (HSAs) are a fully tax-exempt type of account,  which allow pre-tax or deductible contributions, earnings, and withdrawals if withdrawals are used to pay for or reimburse qualified medical expenses.

The Different Asset Allocation Strategies

Every client is different, and so is every account that you encounter. The allocation and location strategies that you have incorporated for client A may not be beneficial to the goals of client B, and so on. You must approach each client as unique and create an investment strategy that is in the client’s best interest and addresses the client’s risk tolerance, goals, timeline, and tax situation.   

Because allocation is the first step in a client’s investment journey, it is often one of the most important steps (aside from making the decision to invest). Any asset allocation strategy should consider a client’s specific risk tolerance and investment length/goal. There are several different asset allocation strategies you and your firm may choose from:

Strategic Asset Allocation Strategic asset allocation is a proportional combination of assets based on each class’s expected rates of return. Traditionally this is referred to as the “buy and hold” strategy.
Constant-Weighting Asset Allocation Constant-weighting asset allocation is much like it sounds – the constant rebalancing of the portfolio. There are no hard-and-fast rules to portfolio rebalancing.
Tactical Asset Allocation Tactical asset allocation requires identifying the short-term opportunities and making small temporary moves for the assets in the portfolio. Think of it as a military mission but within taxable and tax-advantaged accounts!
Dynamic Asset Allocation Dynamic asset allocation requires a constant adjustment of the assets as the market rises and falls.
Insured Asset Allocation Insured asset allocation requires setting an amount in which the portfolio should not be allowed to drop under.
Integrated Asset Allocation An integrated asset allocation approach combines elements from the other allocation strategies and accounts for expectations, capital market changes, and risk tolerances.

Say ‘Hello’ to The Taxficient Score – AKA The Asset Location Score

You may see clients who are demanding and inquisitive and ask you to explain each process you guide them through and the rationale for your recommendations. On the other end of the spectrum, you may also see clients who are not knowledgeable about markets, investing, and taxes. And they may have already made decisions on investing that, when you look at them, appear to have been unwise if they are trying to accumulate for retirement.

For both types of clients – and range in between those two poles – LifeYield provides you with a way to discuss the value of asset location across a household’s accounts. We call it the Taxficient Score, or simply the asset location score.

Remember the movie line, “Show me the money!” (“Jerry Maguire,” 1996) That’s what the Taxficient Score does.

What Does the Asset Location Score Do for Investments?

In short, it pins a score on the tax efficiency of the investments in the client household’s accounts. It swiftly evaluates every holding in every account and scores the tax efficiency of the entire portfolio. To help explain, it assigns a score, between 0 and 100.

Then, LifeYield Asset Location provides a summary of how, by changing the account locations of a household’s investments, the household can lower the taxes it owes today and in the future. The software scores the improvement, again using the scale of 0 and 100, and estimates the potential for tax savings – and more income.  

You can see: When you can put a number to a recommendation you are on firmer ground with every type of client – the investor who is experienced and informed as well as the investor who has doggedly saved for retirement but selected investments and asset locations willy-nilly.

When the changes you recommend, with the help of LifeYield, result in potentially tens or hundreds of thousands of tax savings, clients will stop texting or scrolling emails to talk.

The best part of all is that it works for multiple accounts, which is the new normal today with clients who are eyeing retirement but have filled Easter baskets with nest eggs at their many and varied jobs.

The Million Dollar Question – Can Your Firm Benefit?

You might be wondering if the LifeYield overlay can be beneficial for your firm. It’s already working for many of the industry’s leading firms.