Morningstar Magazine - December 2017/January 2018 - 46

Strategies

7 Ways Software Helps Clients
Manage Taxes
Technology that saves you time and
your clients money is here.

TAX WISE

Sheryl Rowling

Using technology to become more efficient is great
from a practice-management standpoint. But
wouldn't it be even better if the technology saved
tax dollars for your clients also?
It seems like the holy grail-save time for you and
money for your clients. Yet it's out there. You
just have to take advantage of the tools available.

investments, rebalance when necessary, and
provide periodic reports.
Using robust investment management software
can help advisors exceed client expectations
by lowering their tax liabilities and leave their
competition-and the robos-in the dust.
Tax savings can be classified into four
different categories:
1 Current Permanent

(Avoiding short-term gains)
Investment-management software includes three
basic elements:

2 Current Temporary

1 Manage at the Portfolio Level

Many advisors and most robo-advisors manage
on an account-by-account basis. This means
that a "full pie" of asset classes is contained in
each account.
Managing at the portfolio level reduces the
number of transactions (rebalancing won't require
you to buy, say, more global real estate in every
account or sell emerging-markets equity in
every account) and allows for location optimization
(holding appreciating investments in taxable
accounts, income-producing investments in
retirement accounts, and high-return investments
in Roth IRAs) to minimize taxes.
I explain it to clients this way:
"We hold ordinary income-producing investments
in retirement accounts because, if held in
taxable accounts, the interest income is taxable
each year. If bonds are held in retirement
accounts, the tax is deferred. Eventually when
you take the money out, it will be subject
to ordinary tax-which would be applicable
in a taxable account anyway. By holding
bonds in retirement accounts, you at least get
a compounding benefit.

(Tax-loss harvesting)
1 Portfolio Accounting-software (like Morningstar

Office) that tracks each client's investment
holdings, dividends, interest, realized gains/losses,
unrealized gains/losses, returns, etc.
2 Account Aggregation-software (like

ByAllAccounts) that retrieves financial data on
investments held outside of an advisor's
direct management (such as 401(k)s and annuities)
and integrates that data directly into the
portfolio accounting software.
3 Rebalancing-software (like Morningstar

3 Deferred Permanent

(Holding appreciating assets
in taxable account)
4 Deferred Temporary

(Holding bonds in retirement account-
future years)
Current tax savings means that the client will
receive an immediate tax benefit, while deferred
tax savings will be realized at some point
in the future. Permanent tax savings will never
be repaid, while temporary tax savings
might require repayment down the road.

Total Rebalance Expert) that monitors clients'
accounts and calculates appropriate taxefficient trades for rebalancing, cash needs, and
tax-motivated transactions (such as tax-loss
harvesting, capital-gain-distribution avoidance,
and location optimization).

The three types of software-portfolio accounting,
account aggregation, and rebalancing-can help
create all four of the different types of tax savings.

Advisors are expected to make sound investment recommendations, track their clients'

Here are seven ways that bumping up your
software investment can wow your clients:

46

Morningstar December/January 2018

"We hold appreciating assets in the taxable
account. Because appreciation isn't taxed until
investments are sold, the investments are
essentially tax-deferred anyway. However, when
you sell, you will pay capital gains rates
on the gains. If you hold appreciating investments in a retirement account, you will
eventually pay ordinary tax. That would be like
telling the IRS you're OK with paying twice
as much tax.
"Finally, we hold high-return/high-risk investments
in the Roth IRA. This is because the Roth IRA
never pays tax, and we want the biggest bang for
our buck!"
2 Manage 401(k)s

Let's face it: Employees don't pay attention
to their 401(k) investment strategy. They might ask
you to review their allocations every year
or two, but they generally feel lost when it comes
to employer plans.



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