By Donald L. Haisman, CFP®
The changes enacted into law more than a decade ago have had a wide-ranging effect on investing for high-net-worth individuals. The law, with its changes to long-term capital gains tax rates and holding periods, presented real opportunities. However, even though those benefits have been in the tax law for some time, many are not taking advantage of them.
The significant rise in most investments since the low of early 2009 makes it imperative for an investor to understand the pending tax implications.
For many investors, mutual funds were and still are the investment of choice over the past decade or so. These funds are managed with a total return objective, without regard to the tax implications of their trading patterns.
A number of things have combined to create an investment environment in which after-tax strategies are a low priority.
- The traditional marketing of mutual funds as total return investments,
- The fact that mutual fund managers are compensated in large measure based on their performance versus the performance of their peers,
- The high proportion of tax-deferred money invested in many mutual funds.
The Mutual Fund Challenge
The funds, as required by law, distribute capital gains proportionately to their shareholders each year, creating taxable events for those who are not investing tax-deferred dollars. Many people who invest taxable dollars in mutual funds suffer considerable damage to their after-tax return every year because of this distribution requirement. Moreover, if a market correction prompts investors to redeem their mutual fund shares in sufficient quantities to force fund managers to realize large amount of the imbedded capital gains, an even larger tax liability to investors who came “late to the party” may result.
Now may be a good time to consider moving taxable assets from mutual funds into individually managed accounts. Because of the reduced long-term capital gains tax rate, the tax penalty for liquidating mutual fund shares will be less than it would have been. In an individually managed account you can establish your own cost basis for every holding in your account at the time of purchase, eliminating the danger of imbedded unrealized capital gains.
Low Cost Basis Stocks
Another problem that may be solved, in part, by individually managed accounts is the difficulty of liquidating significant holdings in low cost basis stocks. When your best option was to invest in mutual funds, which accept only cash to fund an account, you were faced with the need to liquidate holdings, pay capital gains taxes and reinvest cash in the fund.
You may have hesitated to liquidate these holdings because of the tax penalty imposed. Those who manage individual accounts will often accept cash or securities to fund an account.
A particular sub-specialty has emerged among professional money managers who offer individually managed accounts: those who focus on after-tax strategies. If you fund an individually managed account with one of these after-tax managers using low cost basis stocks, you should be able to orchestrate the liquidation of your overweighed positions. Also, you can coordinate the sales with your overall tax situation over several years, to minimize your ultimate loss of capital gains to taxes.
Consider this alternative and ask about these managers. They will seek the most advantageous opportunities to liquidate the low cost basis holdings and rebalance your portfolio. You will establish a cost basis for each security as of the date on which the manager purchases the security. Among their number, there are money managers who offer all-equity, balanced and fixed income portfolios, giving you a complete spectrum of choices among traditional asset classes. In the world of investing, individually managed accounts should be given serious consideration for your taxable assets.
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Tax Saving and the Individually Managed Account Made for Each Other?
By Donald L. Haisman, CFP®
The changes enacted into law more than a decade ago have had a wide-ranging effect on investing for high-net-worth individuals. The law, with its changes to long-term capital gains tax rates and holding periods, presented real opportunities. However, even though those benefits have been in the tax law for some time, many are not taking advantage of them.
The significant rise in most investments since the low of early 2009 makes it imperative for an investor to understand the pending tax implications.
For many investors, mutual funds were and still are the investment of choice over the past decade or so. These funds are managed with a total return objective, without regard to the tax implications of their trading patterns.
A number of things have combined to create an investment environment in which after-tax strategies are a low priority.
The Mutual Fund Challenge
The funds, as required by law, distribute capital gains proportionately to their shareholders each year, creating taxable events for those who are not investing tax-deferred dollars. Many people who invest taxable dollars in mutual funds suffer considerable damage to their after-tax return every year because of this distribution requirement. Moreover, if a market correction prompts investors to redeem their mutual fund shares in sufficient quantities to force fund managers to realize large amount of the imbedded capital gains, an even larger tax liability to investors who came “late to the party” may result.
Now may be a good time to consider moving taxable assets from mutual funds into individually managed accounts. Because of the reduced long-term capital gains tax rate, the tax penalty for liquidating mutual fund shares will be less than it would have been. In an individually managed account you can establish your own cost basis for every holding in your account at the time of purchase, eliminating the danger of imbedded unrealized capital gains.
Low Cost Basis Stocks
Another problem that may be solved, in part, by individually managed accounts is the difficulty of liquidating significant holdings in low cost basis stocks. When your best option was to invest in mutual funds, which accept only cash to fund an account, you were faced with the need to liquidate holdings, pay capital gains taxes and reinvest cash in the fund.
You may have hesitated to liquidate these holdings because of the tax penalty imposed. Those who manage individual accounts will often accept cash or securities to fund an account.
A particular sub-specialty has emerged among professional money managers who offer individually managed accounts: those who focus on after-tax strategies. If you fund an individually managed account with one of these after-tax managers using low cost basis stocks, you should be able to orchestrate the liquidation of your overweighed positions. Also, you can coordinate the sales with your overall tax situation over several years, to minimize your ultimate loss of capital gains to taxes.
Consider this alternative and ask about these managers. They will seek the most advantageous opportunities to liquidate the low cost basis holdings and rebalance your portfolio. You will establish a cost basis for each security as of the date on which the manager purchases the security. Among their number, there are money managers who offer all-equity, balanced and fixed income portfolios, giving you a complete spectrum of choices among traditional asset classes. In the world of investing, individually managed accounts should be given serious consideration for your taxable assets.
Back to the top