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Tax-Efficient Investing At Scale

Clients who visit your firm looking for investment help are looking for the most tax-efficient strategy, even if they don’t know that is what they need.

As an advisor, the idea is to make the most of a client’s household portfolio by coordinating assets across accounts in the most tax-efficient way. The old method of managing all accounts in a portfolio individually is no longer in the best interest of the client. We all know it. But to do this effectively, advisors and firms need technology that allows them to manage a client’s portfolio as a unified managed household and not on an individual account basis.

LifeYield created this technology for firms that want to help create a more unified and tax-efficient investing strategy for clients.

Explaining Tax-Efficient Investing

Explaining Tax Efficient Investing

All investments have costs assigned to them. Of all the costs associated with investing, the ones that seem to have the most brutal bite are taxes. Taxes often take a massive chunk out of your client’s investment returns, but this doesn’t have to be the case.

The good news for your clients is that LifeYield makes tax efficient investing easier for advisors, helping to minimize the tax drag across their household portfolio and maximize their retirement income.

Types of Investment Accounts

There are two types of investment accounts that your client will come in contact with – taxable accounts and tax-advantaged accounts. Depending on the type of investment account your client has will determine which tax category it falls under.

Taxable Accounts – taxable accounts do not have as many restrictions because they don’t have many tax benefits. If your client holds investments in accounts for longer than a year, these investments fall into more favorable tax brackets. These include what is currently 0%, 15%, and 20% long-term capital gains, depending on the income tax bracket.

Tax-Advantaged Accounts – tax-advantaged accounts are those accounts that provide a tax-deferred status or tax-exempt status. These are accounts like traditional IRAs or 401(k) accounts. The tax is deferred until the client draws down the money for retirement. Roth IRA or Roth 401(k) accounts are initially taxed, meaning when they are withdrawn later, they are exempt from tax. As part of entering this partnership with the government, certain constraints apply that will limit contribution amounts and when and how you withdraw the money.

Possible Ways Clients Can Distribute Investment Money

Taxable Accounts (ex. Brokerage)Tax-Advantaged Accounts (ex. IRAs)
Individual stocks held for at least a yearIndividual stocks held for less than a year
Tax-managed stock funds, index funds, ETFsManaged stock funds that generate short-term gains
Qualified dividend-paying stocks/mutual fundsTaxable bond funds, inflation-protected bonds, high-yield bond funds
Series I bonds, municipal bond fundsReal estate investments trusts (REITs)

When talking about different types of accounts, it’s important to highlight the difference between asset allocation and asset location. Asset allocation is an important part of tax efficient investing. Creating an appropriate asset allocation (the ratio of different asset categories in a portfolio) is one of the first steps that need to be taken with new investment clients. Asset location is different. It involves determining where assets are held within an investment portfolio across taxable and tax-advantaged accounts. While the distinction is key, both asset location and asset allocation go hand-in-hand building a tax-efficient portfolio for a client. Asset location cannot occur until the assets have been allocated.

How LifeYield Changes Tax-Efficient Investment Strategies

How LifeYield Changes Tax Efficient Investment Strategies

Tax-efficient investment strategies were once only applied to one account at a time. Even the software that managed tax efficiency for these types of accounts (before LifeYield) only worked on a single account. LifeYield can work with one account or several accounts to enable a unified managed household for each client.

What does a unified managed household have to do with investing? All the investment accounts of a client and their immediate family should be considered a household. The household-level approach, when looked at as one entity, is a holistic way of managing assets that results in more retirement income for the client, and ultimately, more revenue for the advisor and firm. Looking at the entire array of accounts in a household is the best way to create a tax-efficient investment strategy. This is because all the accounts and the tax implications are viewed full scale. The term for this modern investment strategy is “unified managed household”.

Using the LifeYield Technology Library to Increase Tax Efficient Investments

LifeYield changes the way that firms and advisors approach client portfolios. Beginning with the location of assets, LifeYield looks for all opportunities to improve tax efficiency. When it comes to the household portfolio, LifeYield identifies the optimal location for every asset, then offers the next-best-actions for reducing tax drag and quantifies those benefits in dollars.

Our proprietary algorithm looks at all the accounts within a household to make asset location recommendations regardless of account type. Once assets are efficiently located across accounts, the technology can then execute various complicated scenarios, like making tax-smart withdrawals, harvesting gains and losses, and rebalancing efficiently as needed.

Tax-Smart Withdrawals

When working with tax-smart withdrawals in a household, advisors used to have to manually look through each account and calculate the tax burden of the withdrawal. There was not a way for them to look at the accounts as a whole, only individually. There was also no way of running multiple scenarios at one time to determine which provided the most favorable outcome.

Going further with this, advisors could not efficiently look at the repercussions of the withdrawal and the rebalancing required for the portfolio before executing it. Rebalancing can be complicated, especially if trying to ensure that the tax efficiency remains maximized across the entire household. Rebalancing can be completed extremely easily (if it’s even needed at all) after taking tax-smart withdrawals through the LifeYield technology.

When working with tax-smart withdrawals, LifeYield can pair the rebalancing as a part of the strategy for the entire household. With LifeYield technology, it is possible that a rebalance can follow onto a withdrawal instead of having to hard rebalance after every withdrawal scenario.

Tax-Harvesting

Another strategy for tax-efficient investing is tax harvesting. The most common harvesting scenario is loss-harvesting, which is when an investor sells securities at a loss to offset other capital gains. On the other hand, gain-harvesting is used to identify the optimal tax lots for gifting or charitable donations.

LifeYield Tax Harvesting works with our asset location, rebalancing, and tax-smart withdrawal engines to scan the entire portfolio’s household and find the opportunities available to reduce the tax burden.

LifeYield can work both ways when looking for tax-harvesting opportunities. However, as we said above, most clients are looking for losses that can offset gains in a tax situation. The tax-harvesting capability looks at all taxable and non-taxable accounts, which is important when searching for opportunities to harvest gains or losses and simultaneously avoiding wash sales.

Putting All the Parts Together

Your client’s portfolio and their tax-efficient investing strategy are all like a big machine. At least, that is how it should be viewed. Overall, you want the machine to be an efficient piece of equipment that serves a purpose and doesn’t break down along the way. The goal of investing is to have as much income as possible income through retirement, supplementing the Social Security benefits and pension income your client may receive in the future.

The point of your firm’s actions in this is to be the mechanic to keep the machine running efficiently until it reaches its destination. You do this by allocating and locating the assets for your client, creating withdrawals that are tax-efficient, and determining the opportunities that will mean the most now and in the future.

Not All Taxes Were Created Equal

When your client looks to companies that handle “taxes” for the year, like Turbo Tax or HR Block, they do not account for investment tax efficiency. While they do work with taxes and can help determine the overall tax liability that will have to be paid in the event of withdrawals, they do not tell you the most efficient ways to handle your client’s investment taxes – which LifeYield technology enables.

The goal of using LifeYield is to help all advisors at your firm produce a completely tax-efficient experience from investment through withdrawal, coordinating assets across accounts in the process.

Income Taxes and Short-Term Capital Gains

Taxes are done at two different rates – those assessed for income taxes and those done for long-term capital gains. Short-term capital gains (investments less than a year) are considered with income tax brackets. These brackets change from year to year, but depending on the total yearly income of your client, they may end up being taxed at a higher rate if the withdrawals are not made correctly.

Long-Term Capital Gains

Long-term capital gains are those investments that are held for longer than a year and are taxed at a specific rate determined by the tax bracket and the client’s overall income for the year they are claiming them. The IRS has a more detailed definition here.

The individual tax brackets will see tax rates that equal 0%, 15%, and 20% – determined by the income for the year. Here is where your client can maximize their investments. If there is enough room within their income bracket to convert an investment into a Roth IRA, they can take advantage of the lower interest rate and move the income to the tax-exempt investment account.

Example:

Your client has a total yearly income of $34,000. They want to make a withdrawal from a long-term account to pay for a $3,000 bill they have incurred unexpectantly. When this is withdrawn, they are currently sitting at $37,000 for the year, with the $3,000 taxed at 0%. The threshold for a 0% tax on long-term capital is $40,000. Your client has the opportunity to withdrawal an additional $3,000 and put it in another account, like a Roth conversion, without additional penalty. The benefit of this is that any gains earned by that $3,000 dollars come out of the Roth account tax-free.

The Benefits of Switching to LifeYield Household-Level Management Technology

The Benefits of Switching to LifeYield Household-Level Management Technology

By implementing LifeYield to analyze client’s portfolios at the household level, major benefits can be found for both clients and advisors. With LifeYield, your firm and advisors can optimize tax efficiency across the board for every client portfolio instantly.

The main benefits of LifeYield Tax-Efficiency APIs are:

As advisors and financial firms, the fiduciary duty that you are required to uphold includes placing assets in the most tax-advantaged accounts for the client. The best way to accommodate this is by using LifeYield technology to accommodate all possible scenarios your client’s accounts might encounter. Not all client accounts are going to fall under the same rules. Knowing all the required information takes more time than it’s worth to you. LifeYield knows that these accounts are different, incorporates all up-to-date and relevant information, and always supports execution at the household level.

Increase Tax-Efficient Investing with LifeYield

Increase Tax Efficient Investing with LifeYield

If you need a solution for improving the tax efficiency of your client’s investment portfolio, look no further than LifeYield. Our technology changes the way firms manage accounts and is the only way to obtain the holy grail of a Unified Managed Household.

With so many tax rules and investment account treatments, it’s nearly impossible to manage a complex multi-account portfolio in the most efficient way. LifeYield takes the error out of the equation. Now, your firm can optimize tax efficiency for every household, make tax-smart withdrawals, harvest losses, harvest gains and make the best decisions possible for each client. All of this and more is accommodated with the LifeYield software.

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