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  • Writer's pictureDavid J. Perrotto

Is your Financial Advisor truly tax friendly?

For most of us, tax season ends mid-April. The stress and preparation of going through a complete review of your finances for the year can be harsh. The last thing most of us want to think about our taxes again. So let me be the first and say sorry, but thinking about your taxes for this year, couldn't happen at a better time. Lets find out if your advisor is truly tax friendly.

A review of your tax situation on your investment side might reveal some areas of concern. If you used an advisor to help manage your wealth, or an online platform to help you do it yourself, you may want to go into the details to see how much the advice affected your tax efficiency. Here are some areas to check when seeking to understand how tax-efficient your portfolio performed in a given year.

Tax-loss harvesting. According to, tax loss harvesting is the practice of selling a security that has experienced a loss. By realizing, or "harvesting" a loss, investors are able to offset taxes on both gains and income. The sold security is replaced by a similar one, maintaining the optimal asset allocation and expected returns. Instead of accepting that it dropped and hoping for it be profitable in the future, you can sell the investment and reinvest the rest, in a similar asset 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.

These aren't the kinds of moves you can make at the end of a quarter and expect the market to wait for you. You or your advisor would have to be proactive in managing the portfolio. Every advisor or online platform today should have access to technology that alerts him or her to act. With the advent of better and better technology there's no excuse for an advisor who isn't harvesting your losses. If you own a large gain in a stock that you need to offset, tax-harvesting can help you offset that large tax bill, while keeping your asset allocation in place.

While tax-loss harvesting is a straightforward idea, that many advisors have in place, this next strategy requires a little bit more work, and your advisor needs to know what all your assets are. This is what we call location optimization, and many advisor's don't use it.

For the sake of keeping things simple, we are going to use a simple 50/50 portfolio. That's 50% equities, and 50% bonds, and this investor has four different portfolios. Two taxable accounts, one Roth IRA and one IRA. If each of those accounts are in their own 50/50 portfolio, then the tax implications for the investor may need to be reconsidered.

If your advisor has considered location optimization, you should see the most aggressive investments, 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 hold them for more than one year to take advantage of the lower long-term capital gains tax rate. The 50 bond/50 stock allocation can be achieved inside your total portfolio as all four of your portfolios.

Your situation is no doubt much more detailed than what I described, but having a conversation with your advisor around optimizing your portfolios is a good idea. If your portfolio doesn't fit the traditional mold, it's feasibly of even greater importance. Think about the tax drag on your portfolio every year, when you could take steps to correct it.

And what about short-term capital gains? Where did the money from those requests come from? Did your advisor take short-term and long-term gains into account before he or she sent money? If not, you may have paid a higher tax rate on that withdrawal. A good advisor would hold positions you've held for less than one year and release money from assets you've held longer than a year to incur a much lower tax rate. This translates to 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 no small task to make and 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 run into a major tax mess. Ask yourself, why aren't they? 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 thrown away, and after years, it adds up, and so much is there for the taking, if you have some tax techniques in play.

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