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How tax-friendly is your financial advisor’s advice?

Tax season is officially in the books. Unless you filed for an extension, your 2016 taxes are a thing of the past. The stress of getting through a complete review of your finances for an entire year can be pretty intense. The last thing most of us want to do right now is think about our taxes again. But thinking about your taxes for this year, in light of what happened last year, couldn’t happen at a better time.

A review of your 2016 tax situation might reveal quite a bit of good news — the raise you received, the big bonus when you landed a great new client or maybe your family welcomed a teeny, tiny, adorable tax deduction. If you used an advisor to help manage your wealth, or if you’re using an online platform to help you do it yourself, you’ll want to dig into the details to see just how much the advice you received impacted your tax efficiency.

There are a number of areas to evaluate when you’re seeking to understand just how tax-efficient your financial strategies performed in 2016.


First, let’s look at tax-loss harvesting. If you’re not familiar with that term, it is an investment strategy that you can use when you are invested in a holding that loses value. Instead of just accepting that it dropped and hoping for a brighter tomorrow, you can sell the investment and reinvest the remainder, preferably in a similar asset (keeping you on the right side of the so-called “wash-sale rule”) to maintain your desired asset allocation. The loss can be claimed on your taxes, and your market exposure and investment cash flow will remain the same.

Let’s get specific. In February 2016, there were terrific opportunities for tax-loss harvesting. As the market dipped, did your advisor or online platform sell underperforming assets while maintaining your market exposure? These aren’t the kinds of moves you can make at the end of a quarter and expect the market to wait for you. Paying attention to tax-loss harvesting options requires your advisor to be knowledgeable about taxes and actively watching the market. Frankly, every advisor today should have access to technology that alerts him or her to act. With the advent of better and better technology there’s really no excuse for an advisor who isn’t harvesting your losses.


While tax-loss harvesting is a fairly straightforward idea, this next strategy requires a little bit more tactical prowess. You may be a much more complex investor than the scenario I am about to lay out, but for the purposes of explanation, we can think about a fairly basic portfolio structure.

For the sake of this discussion, we’ll assume that our sample investor has five accounts that should be diversified into 50 percent bonds and 50 percent stocks. If each of those accounts is set up with the 50 percent split across the board (including individual retirement accounts, Roth IRAs and brokerage accounts), the tax implications haven’t been factored in.

If your financial advisor has considered location optimization, you should expect to see the most aggressive investments, or more equities, sitting inside of your Roth IRA because they are growing tax-free. A much larger selection of bonds should sit inside of your IRA, where the monthly or quarterly dividends or interest would be completely tax-deferred. Taxable accounts should have less volatility, so you can hopefully hold them for more than one year to take advantage of the lower long-term capital gains tax rate. The 50 percent bond/50 percent stock allocation can still be achieved inside your total portfolio.

Your situation is probably much more nuanced than what I just described, but having a conversation with your advisor around optimizing your locations is a good idea. If your portfolio doesn’t fit the traditional mold, it’s probably of even greater importance.


And what about short-term gains? Take a moment to look back at any cash requests you made. Did your advisor take short-term and long-term gains into account before he or she delivered your funds? If not, you may have paid a higher tax rate on that withdrawal. A wise advisor would hold positions you’ve held for less than one year and release funds from assets you’ve held longer than a year to incur a much lower tax rate — typically somewhere between 20 percent and 15 percent, but could be as low as 0 percent, depending on your income.

That’s a pretty obvious tax move to make.

It’s not a small task to keep your portfolio as tax-efficient as possible. If your advisor isn’t talking with you about your taxes, and your CPA isn’t talking with you about your investments, you can wind up in a major tax mess. It’s time to break down those walls and have a real conversation before you pay taxes you never needed to pay. So much money is wasted, and so much is there for the taking, if you have proper tax alpha techniques in play.

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