2020 was rough going for many of us. Financially, the hits started early and just kept coming. In some cases, we were forced to tap into savings and other resources to make it through the year—which leaves us eager to recoup that safety net as soon as possible. As the calendar turns over, it is an auspicious time to review last year’s investment decisions, while focusing on the opportunities ahead in 2021. Here are some suggestions to boost your clients’ investment savings for the long term.
We believe one of the best ways to consistently improve your clients’ long-term outcome is to avoid excess payouts by incorporating tax management into their investment approach. The incremental benefits of such a strategy over the long term may surprise you.
Additionally, the likelihood of taxes going up in the future is very possible. Rising public debt is traditionally countered by increasing taxes, as the charts below suggest. The relatively low ceiling for the top tax brackets are ripe for increases, particularly with the incoming federal administration. So planning on a more tax-aware strategy may be particularly timely.
Various techniques may help reduce tax burdens. Accountants can certainly be counted on to help manage annual filings. But they may not be tied into your clients’ long-term investments, which can be frequently overlooked in tax management plans. It pays to keep a close eye on capital gains in investments with longer time frames. Timing of share sales, along with careful weighing of gains and losses with risk factors and expected returns can actually make a large difference to clients’ bottom line.
How large a difference are we talking about? Studies have shown that equity investors tend to overpay by 2% on an annual basis. Such overpayment of taxes is called “tax drag”—and it’s exactly what you can avoid with tax management. Giving up 2% is a lot of money to throw away in any market environment. But in today’s economy, it’s truly a bitter pill to swallow.
Of course, long-term investments with a 2% annual tax drag would lose exponentially more money over the life of the investment. The chart below illustrates the impact a 2% tax drag would have on hypothetical wealth portfolios at a variety of funding levels.
The overall goal of all tax management is to maximize after-tax returns. There are many ways to accomplish this for long-term investments. Clear tax management processes utilize annual tax “sweeps” that help to minimize gains and maximize losses for the tax year. A more sophisticated approach rebalances more frequently, taking into account client-specific tax information, as well as overall investment goals. This is the type of approach we take in PGIM Quant Select.
Clients of wealth advisors can elect for tax management at surprisingly achievable price points with PGIM Quant Select’s separately managed account platform. All accounts are reviewed on a daily basis for tax advantages, and rebalanced frequently — at times that make sense with their particular tax circumstances. This gives your clients more control over their gains and losses, interest and dividends, while weighing tax advantages and disadvantages against the goals of their portfolio as a whole.
Active tax management on PGIM Quant Select’s platform carefully balances the benefits of harvesting tax losses against tracking error (deviations from the desired benchmark) and long-term returns. This personalized approach can offer strong financial advantages over a mere annual sweep, as it takes the timing of each client’s specific tax circumstances into consideration.
Potential savings of up to 2% on an annual basis over time will go a long way to helping your clients regain financial stability after the whirlwind of 2020. The new year brings the opportunity to improve your clients’ long-term savings through tax management on PGIM Quant Select.