Recently, President Biden proposed funding his American Families Plan with an increase of the long-term capital gains rate for those with over $1 million in income, an increase in the top marginal income tax rate for those making over $400,000, and an elimination of the cost basis step up at death on assets over $1 million. The tax policy change that has grabbed the most headlines is the near doubling of the long-term capital gains rate for high income earners to 39.6% from the current level of 20%. Including the Net Investment Income Tax of 3.8% that was instituted in 2013, that would be an effective rate of 43.4%.
The graphic below highlights the potential increase in tax benefit from tax management for those impacted by this proposed changed.
Over the last couple of weeks, this has garnered a lot of attention among advisors and the press, and many have been asking us what we think this means for investors.
Of course, that depends – we don’t know yet what tax policy changes will actually be implemented, but there are certainly implications for tax-aware portfolio management and financial planning if the incentive for pursuing long-term gains is reduced.
But the biggest near-term impact may simply be drawing further attention to a topic that has already been front and center for advisors. Taxes and tax management were already taking on a bigger and bigger role in wealth management, so this is only going to add fuel to that.
In a world of increasingly efficient markets, structurally low portfolio returns, and a continuing shift to passive investments, how will advisors differentiate themselves in terms of investment strategies? For many, we think part of that answer will be through management of taxes. After-tax returns are what ultimately matters – it’s not what you earn, it’s what you keep. If we see higher income tax rates and capital gains tax rates, then managing for after-tax returns only becomes even more important.
Taxes have historically been more of an afterthought – not usually a key factor in selecting investment strategies or mutual funds and only deemed worthy of a little bit of planning one or two times over the year. But that is changing – tax managed strategies are making tax-driven moves an integral part of investment strategies, systematically taking advantage of volatility year-round to extract tax benefit with tax loss harvesting. For accounts that had 55ip’s ActiveTax Technology® overlay for all of 2020, advisors generated an estimated average of 2.58%* in tax savings for their clients.
Tax management isn’t new, but advances in technology and deploying that technology at scale on behalf of investors has really made tax smart investment management the new frontier of wealth management. And tax management is no longer the exclusive domain of high net worth accounts – 55ip uses intelligent automation to bring scalable tax management solutions that an advisor can use across their practice for accounts large and small.
Taxes and tax management are complex topics and can be a real challenge for advisors and clients, but this topic will be in the headlines for some time to come, so it is an opportunity for advisors to reach out to their clients and to raise awareness about tax smart investment management.
We like to describe tax smart investment management as a real painkiller for advisors – this gives them an opportunity to turn the pain point of taxes into a proof point of their value to clients!
For information on partnering with 55ip or leveraging our tax-smart transition technology, contact our Advisor Success Team at (617) 960-9559 or at email@example.com.
Calculation methodology: Average tax savings are calculated by comparing the client’s actual account activity with a shadow account created by 55ip. The shadow account has the same inception date and is invested in the same model as the client’s actual account, but does not incorporate 55ip’s tax-smart technology for rebalancing. Gains and losses are accrued for both the client’s actual account and shadow account to produce the estimated tax bill. The tax rate applied to the client’s actual account and the shadow account are provided by the client’s advisor. If no tax rate is provided, then the highest applicable federal tax rate (20% for long-term gains/losses and 37% for short-term gains/losses) is assumed and an additional 3.8% net investment income tax rate is applied to both accounts. The estimated tax bill of the client’s actual account is then compared to the estimated tax bill of the shadow account, and the shortage of the former amount is the client’s estimated tax savings.
*2.58% reflects the estimated average 2020 tax savings for clients using 55ip’s tax-smart technology based on a composite of all accounts incepted by 12/31/2019 that selected tax management services and were active for the full 2020 calendar year. The tax savings are gross of fees. The deduction of a fee reduces an investor’s return and/or respective tax savings.
There is no guarantee that the estimated tax and subsequent projected tax savings will equal the actual tax liability/tax savings achieved by the client. J.P. Morgan and its affiliates and employees do not provide tax, legal or accounting advice. You should consult your own tax, legal and accounting advisors before engaging in any financial transactions.