Optimizing Investment Portfolios to Minimize Taxes
Insights on mitigating tax liability, tax-efficient investing, and the impact of tax reform on investor portfolios.
New Tax Law – Higher Taxes?
For equity investors the Tax Cuts and Jobs Act is misleadingly named. Federal tax rates for capital gains and qualified dividends, the sources of most of the returns generated in typical stock portfolios, did not change. In fact, for investors in states with a state income tax, the effective rate actually increased. The limitation on the deductibility of state and local income taxes means that taxes paid on gains and dividends at the state or local level may no longer be deductible.
Anticipating Increased Demand for Tax Efficiency
Higher tax rates mean taxes take a bigger bite out of investor returns. The good news is that tax mitigation techniques can have more of an impact in reducing that tax drag. One common technique is tax loss harvesting, or the selling of positions that have declined in value to realize those losses and offset other gains. Employing this technique may be especially important now, in part due to the Tax Cuts and Jobs Act having gone into effect January 1, 2018. That, along with the likelihood that recent market volatility has created more opportunities to harvest losses, is likely to result in much bigger demand for this service, which can strain the operations and trading staffs of asset managers that are not prepared.
New Approaches to Tax Management
This heightened focus on after-tax returns may also prompt financial professionals to consider alternatives to mutual funds that offer structures with better tax characteristics. Separately managed accounts seek to avoid the issue of embedded capital gains associated with commingled investment vehicles; they also facilitate customized investment decision making to harvest losses and defer gains. Historically, separately managed accounts were cumbersome to use, but the proliferation of Unified Managed Accounts (UMAs) has removed many of those hurdles. As a result, asset managers may need to consider making their strategies available in other formats such as separate accounts and model delivery relationships.
2 Longmeier, G. and G. Wotherspoon, "The Value of Ttax Efficient Investments: An Analysis of After-Tax Mutual Fund and Index Returns." The Journal of Wealth Management, Fall 2006.
3 Peterson, J.D. and R. Spiegelman, "The After-Tax Performance of Mutual Funds: Why It’s Important." Schwab Center for Financial Research, September 2, 2003.
All investing involves risk, including the risk of loss. There is no assurance that any investment will meet its performance objectives or that losses will be avoided.
This material is provided for informational purposes only and should not be construed as investment advice.
Natixis Investment Managers does not provide tax or legal advice. Please consult with a tax or legal professional prior to making any investment decisions.