A recent survey found that most affluent investors want their financial advisor or financial planner to have tax expertise and be able to guide in tax-efficient strategies. With recent changes to the tax code, tax-efficient investing strategies are one of the few ways to keep more of what you make.
As an inactive, non-practicing CPA and investment advisor holding the chartered financial analyst (CFA) designation, I find that my tax background helps better serve our clients. With these dual perspectives, we can:
- Discuss opportunities for clients to increase return without increasing risk.
- Consider tax ramifications of investment strategies before implementation.
- Suggest tax-efficient estate-planning strategies.
- Avoid the negative tax surprises that can happen when your investment advisor doesn't consider your tax situation.
Even small incremental efficiencies can equate to significant amounts over time, depending on your income tax bracket. This does not mean you need to eliminate your accountant or CPA. In fact, we work closely with our clients' CPAs whenever possible. In an ideal world, you have both your financial advisor and your CPA working together to identify ways to reduce your tax bill in the current year and beyond. We don't minimize the CPA's role, we simply look for opportunities to add tax-efficient investment strategies as we help implement long-term financial planning strategies based on your needs and goals.
Investing without considering tax ramifications
Advisors should be aware of and sensitive to your tax situation, but sometimes problems may be hard to detect unless you know where to look. For example, the client may not disclose all the accounts he or she has, so an advisor won't know how other accounts are invested, or more importantly, what the gain or loss landscape may reveal.
An advisor who is fluent in the tax strategy will ask about other accounts in order to avoid realizing a gain or loss in error thus creating an unanticipated tax issue. Simply put, a financial advisor with tax experience has the mindset to always be on the lookout for ways to save on taxes. Even if they switch careers, they likely don't lose that instinct.
On the other hand, financial advisors are usually investment professionals first. They are looking to grow your assets, and tax consequences may not be a priority, particularly if that advisor is paid on a commission basis.
Combining the long-term investment planning mindset of an advisor and the tax-savings mindset of a CPA, however, can be a great thing for your investment strategy.
Managing risk and tax-efficient investing
With long-term investing, investors must be comfortable taking more risk to potentially realize higher returns. And as their wealth increases, many investors begin to shy away from taking risk.
This is where tax-efficient investing can be critical. By combining proactive tax planning and estate planning strategies, you can feel more confident about the management of your wealth and the risks you are taking to grow your legacy. It is possible to realize a better return with the same amount of risk by efficiently managing the tax burden.
Whether it be simple management of positions in the right accounts, or harvesting gains and losses in a strategic way, almost every investor can benefit from a tax-smart investment review. In other cases, there are opportunities to create interesting estate planning strategies that can serve your legacy.
When you employ several different firms for these critical tasks, you may sacrifice potential tax saving opportunities. A tax-smart advisor can often identify these opportunities or deficiencies during the financial planning process.
Awareness is paramount. An advisor on your team that looks for ways you can pay less in taxes should increase your returns over long periods of time. The tax-savvy wealth manager is a great asset for any investor.
"You will be well served to search for financial advisors with tax and accounting experience. Ensure that the advisor in question is a fiduciary, and check out their compliance record at BrokerCheck."
Managing tax impact of gains
You might have experienced this before: Your advisor encourages you to take some profits. Suddenly you've got a tax bill on your hands you weren't expecting and your cash flow is going to suffer.
Your CPA should always be looking for ways to lower your taxes in the current year. Your financial advisor should be seeking prudent avenues to grow and protect your wealth, based on long-term financial planning discussions during the investment planning process. However, these goals of saving tax and growing wealth can sometimes conflict if the efforts are not coordinated.
This is where a strategy such as proactive tax-loss harvesting can make sense. You can still take the profits, but you can offset the potential tax bill. By including tax planning along with your investment planning, you can smooth those situations and minimize surprises.
How to find a tax-smart advisor
Some might think it makes good sense to consult your CPA for investment advice. But investment planning and implementation are quite different from tax planning. Ideally, you want someone who has experience on both sides. You will be well served to search for financial advisors with tax and accounting experience. Ensure that the advisor in question is a fiduciary, and check out their compliance record at BrokerCheck.
Once you find an advisor with the capacity to be held to a fiduciary standard, don't be afraid to ask questions to help you make the best choice:
- Does he/she or anyone on the team have experience or training in tax planning?
- How will your portfolio be structured to balance growth with tax savings?
- What investments make the most sense for your tax situation?
If a prospective advisor doesn't provide satisfactory answers to these questions, keep looking. To truly grow your net worth, investment expertise is vital and tax expertise is essential. It's best to find an advisor with both.
(Editor's Note: This column originally appeared on Investopedia.com.)
— By Ryan Warwick, investment advisor and principal at Rathbone Warwick Investment Management