Taxes Reduce Net Investment Returns
Forty-one states impose a tax on capital gains. Those rates averaged 6.37% for the 2020 tax year. But for investors residing in California, the maximum state capital gain rate was 13.30%. When these state taxes are combined with Federal taxes, the combined tax burden on investment returns can exceed 50%. Fortunately, there are resources available to investment advisors to mitigate this drag on investment returns. Sawtooth Solutions can employ a number of different tax management techniques as a value-added service that can reduce or defer this tax burden.
Tax Loss Harvesting
Tax-loss harvesting has long been recognized as a way to increase after-tax returns in a portfolio. Advisors have traditionally examined gains recognized through the end of the tax year as part of year-end tax planning. Next, they look for unrealized losses that can be realized or harvested in offsetting transactions. Unfortunately, the optimal time to look for losses is often not at the end of the tax year. As the market cycles up and down throughout the year, there can be multiple loss harvesting opportunities.
While remarkable in many ways, 2020 was not unique in this regard. By continuously monitoring portfolios for loss harvesting opportunities, Sawtooth was able to realize losses throughout the 2020 market cycle instead of at year-end when the market had rallied, and loss harvesting opportunities were scarce.
Wash Sale Monitoring and Avoidance
While loss harvesting is simple as a concept, it can be challenging to implement successfully. Most advisors know that once a trade is placed to realize a tax loss, that the same security (or any substantially equivalent security) cannot be purchased for thirty days. These trades are called wash sales, and the losses realized are not available for tax purposes.
Tax Efficient Transitions
Tax-efficient portfolio management often begins before the first trade. Frequently accounts are funded with low-cost basis securities. And unless the client is willing to realize all their embedded capital gains, some or all of these holdings will need to be retained.
Clients frequently want to establish a tax budget. Whether as part of a portfolio transition strategy or routine portfolio management, clients use tax budgeting to eliminate unexpected year-end tax liabilities. Fulfilling these requests can be difficult as gains are often realized due to routine manager trades or re-balancing. Sawtooth can utilize ongoing gain/loss matching to reduce the net realized gains from these trades while honoring the client’s tax mandate.
This information is intended for general informational purposes only; it is not investment advice. The material on this website does not consider the specific investment objectives, financial situation, needs or special circumstances of any particular person. This information does not represent the suitability of any strategy, financial product, security, or other instrument. Past performance is not a guarantee of future performance.
Sawtooth Solutions, LLC (“Sawtooth”) is an investment adviser registered with the U.S. Securities and Exchange Commission. The information on this website is for informational purposes only and is intended as an overview of the services offered by Sawtooth to financial advisors. Nothing contained on this website is a solicitation for investment. Any individual investor seeking more information should consult with their financial advisor.
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