• attract client assets and increase share of wallet with current clients,
• boost recruitment of advisor teams from other firms,
• improve tax outcomes for existing clients, and
• ensure tax-optimal execution of client-driven events

At Vestmark, we often talk about the advantage you get from maintaining tax-lot-level detail within multiple “sleeves” for a single client. We believe this allows for better optimization of tax outcomes under current tax rules and, importantly, will continue to do so if enforcement of the wash-sale rule starts extending to entire households. Here are two examples that illustrate the benefits.

Tax-Aware Account Transitions

Some transitions are simple. If an inbound client has been using an SMA that is also available on your platform, shares are simply transferred-in-kind with special attention paid to maintaining lot-level details (cost basis and purchase date). If the inbound client’s SMA is not available at your firm, however, the transition is more complex.

For many years, bringing over SMA assets from other firms involved a rudimentary “overlap analysis” that compared existing stock symbols to the symbols in approved SMA portfolios of similar style. Identical names were retained (perhaps adjusting position weights in a tax-aware way) and the remaining names were sold to purchase new names, possibly resulting in a significant tax cost to the clients. In the later years of a bull market, this tax cost could present a serious barrier to attracting new clients and new advisor teams.

Vestmark’s tax-aware transition service can help solve these challenges in several ways:

1. We look to retain legacy positions with performance characteristics (“factor betas”) that resemble those of the target benchmark, resulting in fewer sales of appreciated securities.
2. We identify lots for sale using HIFO accounting (highest in, first out), which typically results in better tax outcomes than the more commonly used FIFO (first in, first out) and LIFO (last in, first out) methods.
3. Lot-level analysis also allows us to identify unrealized tax losses that may be obscured by statement aggregations showing average cost basis, including identification of long-term and short-term gains and losses to ensure the most tax-optimal outcome for each client for each security being traded.
4. Virtually any portfolio of individual securities can be mapped into one or more index-like portfolios, removing the burden of finding “best-fit” SMAs for inbound SMA assets.
5. The tax management opportunities in direct index SMAs help the advisor and client to see, discuss and balance tax cost vs. overall expected risk/return trade-offs.

Ongoing Tax-Loss Harvesting

Maintaining tax-lot-level detail within a portfolio of SMAs presents opportunities to capture tax losses when the opportunity arises. (This is especially advantageous within direct indexing SMAs because the numbers of holdings and available substitutes are not as constrained as they would be in an actively managed portfolio.)

Some firms focus on harvesting losses only at a point in time – quarter-end or year-end for example – but the ideal and most effective way to manage your client’s overall portfolio tax burden is to look for and take advantage of opportunities to realize losses throughout the year. This can happen when a rebalance takes place, when the client requests a withdrawal, or when there is some market volatility and there are unrealized losses available to utilize.

Short-term losses provide a greater tax savings than long-term losses, whereas long-term gains carry a lower tax cost than short-term gains. Vestmark’s use of HIFO accounting (highest in, first out), promotes the minimization of taxable gains through acceleration of tax-loss recognition (generally into the short-term range) and deferral of capital gain recognition (generally to long-term).

Recognized tax losses from harvesting activities can be used to offset realized capital gains elsewhere in a client’s portfolio, helping improve the after-tax performance of a client’s entire account. If no gains are available to be offset, harvested losses can reduce a client’s taxable income by $3,000 per year or carried forward for use in future years.

Vestmark has the technology and experience to help advisors tax optimize accounts in a variety of client situations. Contact us to learn more.

Tax Transition services offered by Vestmark Advisory Solutions (VAS). VAS does not provide tax or legal advice.