For example, what if you could realize losses on some of their investments and offset other capital gains taxes they are required to pay? Luckily, every financial firm and advisor can leverage this – in the form of tax harvesting.
Tax harvesting comes in two forms, tax-loss, and tax-gain harvesting. The purpose of the sale informs the type of harvesting you are doing. Both strategies are beneficial to clients, advisors, and firms. But under the surface, it becomes imperative to have a complete tax harvesting solution that goes in both directions and considers all taxable and non-taxable accounts.
Creating a Tax Harvesting Strategy
Tax harvesting is likely something your clients know nothing about unless they have encountered it before. As the firm that manages all a client’s finances and portfolio distributions, it becomes your responsibility to do what is ethically correct for your client and their financial situation.
What is Different Between Tax-Loss Harvesting and Tax-Gain Harvesting?
Tax-loss harvesting is the process of selling a client’s stocks, ETFs, mutual funds, or other securities at a loss to offset the gains realized when selling other investments. Tax-gain harvesting is the opposite, where your advisors sell the investments to realize a capital gain.
What is the challenge associated with finding tax-loss and tax-gain?
Traditional harvesting is a tedious process. Many advisors are required to use multiple spreadsheets for accounts and holdings, running them through complex formulas and macros to identify and organize specific trades. In addition to this, identifying the most appreciated tax lots for gift-giving or what to sell to counteract losses can be a difficult task. Doing this across books for numerous clients can take days or even weeks to accomplish.
What is the solution for firms and advisors?
LifeYield has the solution for firms and advisors to quickly identify the potential for tax-loss or tax-gain harvesting. The proprietary technology instantly identifies all of the opportunities available to harvest gains and losses across client accounts during any scenario.
LifeYield Tax Harvesting works with LifeYield’s asset location, rebalancing, and multi-account withdrawal engines to help firms tap into all areas of tax efficiency at scale.
What The Tax Harvesting Engine Does
The LifeYield proprietary tax harvesting engine considers multiple scenarios when factoring the loss and gain opportunities of unified managed household portfolios.
- Harvest Direction: Even though tax-loss harvesting offsets capital gains or income is the most common use, tax-gain harvesting can be used to identify the highest appreciated tax lots for gifting or charitable donation.
- Holding Period: Depending on the tax rates that a client is exposed to, the important factor is having a solution that can maximize tax harvesting for any time period.
- Maximum Gain or Loss: LifeYield allows firms and their advisors to set limits for gains and losses on each client’s portfolio. The goal is to minimize the tax impact of the transaction. This strategy is best used when trying to find out how to offset a specific number of gains or losses.
- Maximum Proceeds: Put a limit on the total value for suggested sales, no matter the gain or loss. It becomes important to have this lever when the whole transaction needs to stay under a specified dollar amount.
- Avoid Wash Sales: In most circumstances, wash sales occur with taxable accounts only. LifeYield looks across both taxable and non-taxable accounts to identify any potential wash sales. Advisors can avoid the wash sale now or allow it to happen, assuming that the account manager will adjust the cost basis instead.
What is a Wash Sale?
The IRS created a wash-sale rule to prevent taxpayers from claiming artificial losses. The rule states that a loss cannot be realized if the taxpayer replaces the sold securities within 30 days of the sale. The wash sale can occur across accounts and if there is no communication between portfolio management across accounts.
Here is an outline of how a wash sale works:
When there are multiple accounts managed by different firms, the potential risk of wash sales becomes more apparent.
Firm 1 handles three investment accounts:
- XYZ: 100 shares
- ABC: 57 shares
- GHI: 150 shares
Firm 2 handles two more accounts:
- CDE: 125 shares
- FGH: 75 shares
On December 15, Firm 1 sells 100 shares of XYZ to harvest the loss for tax purposes. On December 28, Firm 2 sees an opportunity to purchase stock at a low rate and acquires 100 shares of XYZ.
Firm 1 tries to realize the loss from XYZ at tax time, but it is rejected because Firm 2 bought the stock within 30 days for the same client. Due to this, the firm cannot realize that loss, and it is considered a wash sale.
The Best Time for Investment Tax-Loss Harvesting
The best time is when it helps improve outcomes for your client and helps them keep more of what they’ve earned. Advisors can constantly be looking for gains and losses to harvest for their clients, but the opportunity is especially prudent when clients are looking to take a distribution or perform a strategic withdrawal. If your firm doesn’t have the technology to scan all accounts within a client’s unified managed household, it can become a time-consuming process. Tax harvesting can add significant work to a fairly simple transaction if you’re not using the right technology.
LifeYield makes the process of harvesting losses and gains a whole lot easier. It even does it automatically. LifeYield looks across all accounts – taxable and non-taxable – trying to locate the best opportunity to harvest gains or losses during any transaction. Rebalancing? Let LifeYield look for tax harvesting opportunities on the back end. Taking a withdrawal? LifeYield can rebalance and harvest gains or losses at the same time.
So how does your firm benefit from using the LifeYield Tax Harvesting engine?
- You can keep your current technology – LifeYield Tax Harvesting can act as an overlay to the current technology in your stack and enhances your firm’s modern tax efficiency capabilities.
- Limit capital gains for your clients – You can help your clients offset the short-term and long-term capital gains with automatic tax-loss harvesting. LifeYield can set the priority to short-term but can also account for both.
- Identify appreciated lots for your clients – Sell winning investments to realize gains for clients. Use this to find the most appreciated assets for gift giving or charitable donations.
- Avoid wash sales – LifeYield lets advisors scan both taxable and non-taxable accounts across the entire household to reduce the occurrence of wash sales.
The LifeYield Tax Harvesting engine works with the other proprietary technology available to help firms and advisors provide quality and tax efficiency for advisors implementing unified managed households.
The LifeYield Technology Library
The LifeYield Library of Technology offers firms and advisors an advantage when handling the investment accounts brought to them by a client. The right approach to managing each client’s finances is not always uniform. There are no two portfolios that you will come across that match 100%. All scenarios are going to have special qualities and requirements.
LifeYield uses a mindset and mission called “householding” as a basis for our technology. Householding is the practice of managing and coordinating all a client’s accounts and holdings to achieve the greatest possible after-tax return. The idea is to take the asset allocation to the household level rather than managing each account individually.
When done right, all accounts with the portfolio will look different. What’s held in a Roth IRA will be completely different than what’s held in a brokerage account. This is by design – because different accounts have different tax treatments across the portfolio. And there’s a right and a wrong place to hold every asset when it comes to tax efficiency.
Asset location is a strategy that is used to determine what accounts money should be placed in to minimize taxes. Unlike asset allocation, which focuses on how the funds are allocated within a portfolio, asset location focuses on the location for the best tax optimization strategy.
LifeYield Asset Location helps advisors and their clients avoid unnecessary taxes to keep more of the assets invested, increasing the revenue for the advisor and the retirement income for each client. It simplifies the conversation about taxes with the addition of LifeYield’s Taxficient Score, which is essentially an asset location score. The portfolio is benchmarked with a score from 0-100, then the LifeYield engine recommends a series of actions to increase the score.
Using an easy-to-digest number along with the dollar benefits associated with each activity can help clients completely understand the impact of all the moves an advisor makes. What’s traditionally been a black box for advisors can now become their competitive advantage.
LifeYield’s tax-smart withdrawal engine looks across all accounts within the household and chooses the right accounts to pull from to minimize the tax burden of the transaction. Advisors can finally withdraw funds across accounts instantly without having to do complex calculations and analyses.
Looking across all the accounts allows the technology to make the right choices on which assets to sell to minimize drift, pay fewer taxes, and offset gains or losses.
Rebalancing needs to happen periodically to keep portfolios in alignment with the target asset allocation. Especially after taking a withdrawal, rebalancing is key to staying on track with a client’s investment goals and keeping their risk profile intact.
When LifeYield executes a rebalance, it assesses the tax efficiency across the household and looks for ways to improve it. Firms can pair rebalancing with tax harvesting and asset location for the best results.
Why Tax Harvesting Sets Clients Up For Success
Tax harvesting makes it possible for clients and their advisors to make tax-efficient choices when handling each investment. What is good for one investment account tax strategy may not be good for another. Market conditions are always changing, making it challenging for both the firms and the advisors that handle these accounts to stay on top of tax laws and relevant information.
Because there is a level of uncertainty, it is important to provide as many levers as possible for advisors to control outcomes. Taxes represent the largest drag on investment returns. But they’re also something the advisor can control. We can’t control market performance, but you can place current holdings in the most tax-advantaged accounts, rebalance effectively, and look for tax harvesting opportunities. This increases returns for clients over the long haul.
The success of an investment account directly relates to the success of the entire household portfolio, not just retirement accounts, stocks, bonds, or other assets. The whole household is what creates the winning strategy and must be managed together, not just the individual accounts. Traditional tax harvesting technology that firms and advisors are used to working with only looks at one account at a time. They were not designed to work at the household level – until LifeYield.
Choosing LifeYield Tax Harvesting For Your Firm
Offsetting income or capital gains has long been a tedious process. It typically involves multiple spreadsheets of accounts and holdings running through complex formulas and macros to identify and organize meticulous trades.
Additionally, it can be difficult to identify the most appreciated lots for gift giving or what to sell to counteract other accumulated losses. It can take multiple associates days – or even weeks – to properly execute this process across a book of clients.
LifeYield’s tax harvesting engine (accessible via API) looks across all a client’s accounts and holdings and instantly identifies all opportunities to harvest gains and losses. It works with all of LifeYield’s tax efficiency APIs to turn gains and losses into tax alpha for clients. Using technology that doesn’t accommodate the multiple accounts leaves a gaping hole in your firm’s advisor technology platform. LifeYield technology handles multiple accounts with ease.
Overall, LifeYield solves the most complex tax efficiency challenges for the largest financial institutions in the world at scale.