How to unlock tax savings in incoming client portfolios

An incoming client could turn into a lifetime customer if their new financial advisor or tax professional finds savings on their payments to Uncle Sam during the transition.

Continuing industry consolidation through recruiting moves and M&A deals test advisory practices' scale and onboarding abilities. That influx of client portfolios to a different wealth management firm or technology platform presents opportunities for tax savings through strategies such as loss harvesting, winding down big stock concentrations and rebalancing of their asset allocations, advisors and other industry experts told Financial Planning.

"If the financial advisor is also a tax professional, it's a single touchpoint for managing the customer relationship and guiding the client through suggested changes while explaining the rationale," Rupa Pereira, the founder of Apex, North Carolina-based FWJ Planning, said in an email. "In other cases, it's a facilitative process so the client is informed of the current state and federal tax implications of no action and gets recommended changes in order of urgency. The advisor and tax professional will need to tag-team so it's a seamless process for the client."

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After ensuring that the portfolio aligns to the clients' goals, advisors could begin checking the tax efficiency of their overall financial picture by looking at their latest Schedule D to see if there are any capital losses they're carrying over from the prior year and examining the investment holdings for any unrealized gains or declines, according to Jack Oujo, founder of Wall, New Jersey- and Fort Lauderdale, Florida-based Oujo Wealth Strategies. 

Large, highly appreciated stock concentrations equate to "tax bombs" that need defusing through charitable giving with donor-advised funds or charitable remainder trusts, he noted in an interview. In the case of older, wealthier clients, they could also hold that stock until their deaths so their heirs avoid paying taxes on the appreciation through the step-up in basis, Oujo said. With time, some of that yield may fall in a down market for stocks as well.

"Sometimes we let a portfolio go without being rebalanced if it will hurt a client from a tax point of view," he said. "If we sell off these positions, we'll be creating our own crash with all the taxes we'll have to pay."

The combination of industry consolidation and healthy stock values over roughly an entire decade after the Great Recession create "more of a scale problem than ever before" for advisors and their clients, according to Anton Honikman, CEO of MyVest, a wealth management technology subsidiary of TIAA. That means transitions to a new firm often pose tax implications.

When an advisor "has multiple clients that are in transition at any point," they can work with the tax overlay software through MyVest or other technology firms that are increasingly offering that service to offset capital gains with losses to ensure there is a "consistency of care across the book of business" without trying to handle the entire workload, Honikman said.

"Any losses give you more gains that you can harvest. We provide the technology to automatically apply all of them," Honikman said in an interview. "The ongoing implementation can be done by someone else."

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As part of this evaluation of new clients' portfolios from a tax perspective, advisors should keep in mind that long-term capital gains in stocks and dividends often bring lower rates than bond income, Pereira noted. However, in taxable brokerage accounts, municipal bonds as well as stock indexes "are tax-friendly choices," she said. The timing of any rebalancing and distributions and the location of the assets loom large in importance as advisors confront the typical tax pitfalls of incoming clients' accounts.

"The most common area is the asset selection between taxable/deferred and tax-exempt accounts where the investment selection may not always be tax-optimal for respective asset location," Pereira said. "Another common area is not accounting for overall portfolio allocation across all the individual client accounts that could lead to asset imbalance relative to risk tolerance."

Planners may consider setting up a technology-assisted "gains budget" for the new client to decide how quickly to liquidate concentrated stock, Honikman suggested. Since the tax savings represent "a really helpful share-of-wallet enhancer," the management of the timing of the selloff each quarter or year can create the optimal short- and long-term capital gains, he said.

"You're highly likely to see embedded gains coming in. It's just something one should expect," Honikman said. "There is a balancing act to staging that diversification over time."

Above all, advisors can use the transition time to coach clients on the value they can unlock through the tax savings on stock losses, so that, "When the red arrows are on CNBC, they don't have to call us and panic and scream," Oujo said.

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For whatever reason, the comprehensive calculation of losses and gains against cash flow from individual retirement account distributions in the pre- and post-retirement phase tends to register with women more easily than men, Oujo noted.

"If a man goes from $2 million to $1.8 million, they don't like it. If you can explain to them that their interest and dividends are still there, it's like a magic trick," he said. "Cash flow is a big deal to a retiree, and doing it in a tax-efficient way is very important."