One Net Worth and One Tax Rate | AWM Insights #124
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Episode Summary
Tax planning is the backbone of the family office. A tax team focused on minimizing your taxes is a must-have for families to optimally grow wealth and then sustain it multi-generationally. These opportunities are often missed because most Americans invest money only in their company 401k or an IRA. But for anyone high net worth, taxes are the biggest cost to control.
The highest tax brackets also present the numerous opportunities in tax planning. But to take advantage your tax advice needs to be integrated with the rest of your team. Ignoring the costs of taxes by using a separate CPA is not efficient and will end up resulting in paying more in taxes than is otherwise necessary.
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Episode Highlights
(0:55) Integration of tax planning is the backbone of a multi-family office and is also the least appreciated.
(1:05) Most investment advisers cannot legally give tax advice. This comes at a big cost to any of their clients that are high net worth.
(2:05) Just being tax aware is incredibly powerful. You have one net worth and one tax rate which just means all roads lead back to the single tax return filed each year.
(2:27) Keeping tax drag as low as possible in your investment accounts, leaves more money to compound and grow.
(3:00) Sometimes these opportunities are small in any given year but over a lifetime of savings, the impact can be incredible.
(3:17) It’s very easy to find little savings when you’re doing tax planning.
(3:28) Tax loss harvesting is a prime example. This year has been one where taking advantage of this tax planning strategy will save clients money in the future.
(3:59) Minimizing costs, which taxes are the biggest cost within a financial structure, results in maximizing returns. Other costs or frictions include trading costs, expense ratios, and fees.
(5:15) Most people in America don’t need to worry about taxes. They save their money in their company 401k and IRA accounts where tax loss harvesting doesn’t do anything.
(5:46) Great question to ask your advisor: when do you take a look at tax loss harvesting? Most advisors just do it at the end of the year which is a missed opportunity and you're missing out on tax savings.
(6:30) CPAs aren’t in your portfolio looking at your situation daily. They won’t be able to take advantage of tax loss harvesting like an integrated team does.
(7:26) CPAs that are not integrated with your investment team are going to miss advantageous tax planning strategies because they are only looking at your situation at a single point in time during the year.
(8:08) Asset location is another tax strategy that boils down to putting tax-efficient assets in taxable accounts and tax-inefficient assets in deferred accounts. You shouldn’t have the same holdings in every investment account you have.
(9:30) Are you familiar with a back-door Roth IRA or non-deductible IRA conversion?
(10:40) If you start early, the results can be dramatic when taking advantage of these opportunities to reduce the tax drag on your wealth.
(11:03) Giving cash to a charity is wasted impact because there are simple ways to give even more through gifting appreciated securities. The tax code encourages you to do this.
(12:02) Donor-advised funds are an incredible tool to maximize charitable impact and even foundations at a certain level of wealth.
(12:48) Your team should be focused on minimizing taxes and when you’re high net worth there is a lot of opportunity and flexibility to be more efficient here. Growing wealth effectively must include reducing costs and taxes is the biggest of them all.
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+ Read the Transcript
Brandon Averill (00:04): Well we're back and we're going to talk a little bit more on this series here, how to plan for ultra high net worth families. But I don't think this is just for ultra high net worth. I think there's lots of value that can be gained for a lot about what we're going to talk about today. And ultimately I'm sure everybody listening is on that path to wanting to at least have this ultra high net worth problem if you want to call it that, more money, more problem sometimes, but also more opportunities. And so what we thought we'd dig into today, we're going to take the next few episodes to actually dig into some of the high level strategies, if you want to call them that, but subsections of how we actually think about planning, and we're going to start off with really where we started our company and where we decided, Hey, we need to have a different model. And that's integration of tax planning. Unfortunately, the financial structure, the models, the companies that exist today, where we started at Morgan Stanley, a lot of times they don't allow you to get into this type of work. And it makes sense. It's risky for the organization, but really is kind of the backbone of one of the main powers of a multifamily office. And so as we started to think about the importance of tax planning to our clients, some of these strategies that we're going to talk about certainly really shine. So kind of digging in there, Justin, a little bit, as you think about, especially as the CIO, as the person that's really guiding our planning process, as you think about the integration of tax into a high net worth family situation, what are some of the big things that you would say come to mind immediately? Justin Dyer (01:48): Well, tax being one of the most important aspects of an investment portfolio and a broader just wealth strategy overall, that's first and foremost, not a direct answer to your question, but it is incredibly powerful if you can be just tax aware, minimize taxes. We like to say you have one net worth, you have one effective tax rate. If you're not thinking about all of those things or both of those together and optimizing them, you are leaving money on the table quite simply. And from an investment standpoint, the few things that immediately come to mind are just keeping taxes within a portfolio or tax drag is a way to think about it within a portfolio, as low as possible, just leaves more money in your investments, in your accounts to continue to compound over time. Right. There's that famous saying compound interest is one of the most powerful forces in the universe. And it's a tongue in cheek saying, but it's also incredibly true, right? If you can minimize or maximize, add to your rate of return incrementally, very, very small little percentage points, we call them basis points in our industry, excuse me. And you start, if you just do a simple math problem, you say, okay, 1.1% versus 1.25%, and look at the difference over a 20, 30 year period of time. It's incredible. And it's really easy to find little savings like that from a tax planning perspective when it comes to investments. Some specifics around that, we talk about this a lot tax loss harvesting. When markets give you the opportunity, it's not necessarily a fun market environment to be in. We've seen it a lot this year, where markets have declined, not in substantially, it's been a more challenging year for sure, but Hey, we can't predict those things, but we can take advantage through things like tax loss harvesting when opportunities arise. Taxes are one component, but I want to put this broad expense or cost term or umbrella around this conversation as well, where really at the end of the day, what we're talking about is minimizing costs or minimizing expenses or frictional forces within a total financial structure. Investments are a big portion of that. That's what the question was. And that's what I focus on quite a bit, but we are very much a total financial structure, total net worth driven firm and optimizing everything that goes into that equation. And so taxes are one of the biggest costs that are incurred within a total financial structure, but there are other costs within investment costs, trading costs, transaction costs, et cetera, where you need to think about all of these together to minimize them for the exact same benefit. Right. You can only consume, continue to invest and give ideally at the end of the day, your net after tax returns. And so really maximizing them is a key driver to long term growth.
Brandon Averill (04:51): And I think that's a great point to hit on. And I think also giving some contexts on who ultimately should be responsible in these situations for making sure these things happen and why maybe some people don't pay enough attention to them. So tax loss harvesting, great example, we have talked about it a lot, but if you think intuitively about this and this episode is about advising the ultra high net worth, most of America, this isn't applicable to. Most people save their money in retirement plans, either their company 401k or in IRA. These are all tax-deferred vehicles. Tax loss harvesting has no benefit.
Justin Dyer (05:28): Right.
Brandon Averill (05:28): So you don't actually have to go through this process. So many advisors, maybe they put it on an annual schedule. Great question to ask your advisor. When do you guys take a look at tax loss harvesting? The unfortunate answer is most people, most advisors take a look at once a year, usually in the fourth quarter. At the end of the year, they're going to look at your portfolio. Are there any losses that we can harvest here? You want a more robust strategy, no matter who you are. It's just that oftentimes advisors aren't paying attention, aren't in tune with this because it's just not as applicable to all of their clients. So that's one big reason, and this is going on the advisor. So many people want to separate tax and investment and planning because they think checks and balances, et cetera. We've heard this before. We've talked about it before. I think it's unfortunate because it's a misleading argument really by the big wirehouses that can't do the tax planning.
Justin Dyer (06:27): Yeah. Shock.
Brandon Averill (06:28): Yeah. But at the end of the day these CPAs, they're not in your portfolio every day. They're not looking at your situation every day. They're gathering their information at a point in time and doing what they're great at. And that's actually filing the returns, the compliance, looking for those write offs that most people probably think about when they're thinking about tax mitigation, et cetera. But what often gets missed across the board here without this integration is even beyond the implementation in the portfolio, right, it's actually the little things you do, like evaluating Roth conversions, evaluating whether we should be maximizing HSA, health savings accounts. Do we contribute to the pre and the post-tax of our 401ks if we have those. Really thinking through what are all the different account structures that we can take part in. And unfortunately, a lot of times these are things that the CPA misses again, because they're looking at your situation at one or maybe two points in time during the year, and then your advisory firm, if they're not focused on tax planning, probably miss as well.
Justin Dyer (07:38): Yeah, totally. Well and taking that concept that you were introducing it even a level deeper, right, we can start to think about, well, once we've made the decision to make a contribution or maximize a 401k or Roth 401k or done a Roth conversion or a backdoor Roth contribution, all these planning tools, each one of these are unique and there's a benefit to it. But then how do we take that money and invest it? Well, there's a tax maximization strategy around that. It's called asset location. Each one of those accounts has a different tax nature. And if you go back to this idea of you have one net worth one effective tax rate, each one of those buckets should roll up to a broader portfolio or a singular strategy not invested in each and every way, the same, right?
Brandon Averill (08:31): Right.
Justin Dyer (08:31): So often you see a Roth account invested the exact same way as a taxable account or whatever the case may be, where the strategy is just the exact same across the board. And it's just silly. Again, you're not being efficient, you're not optimizing your net worth and your tax rate where really what at the end of the day makes sense, looking at things as one, and then putting the tax efficient assets in taxable accounts, they're going to have a lower tax track. Again, these are the things just to minimize your overall frictional cost of the portfolio to get these basis points. And in some cases it's actually much more than basis points or tenths of a percent. You can start to get close to a single percentage point and that's substantial savings and substantial rate of return to add again to your portfolio so it continues to compound over long term.
Brandon Averill (09:24): Yeah. And I think it's really interesting. Another quick question I think you can ask of your situation is, am I familiar with what a backdoor Roth IRA is, right? That's something we see missed all the time, more commonly, or maybe less commonly called, but a non deductible IRA. If you're hearing those terms with your advisor, that's probably a pretty good sign, but those are things that you should be just chipping away and continuing to take advantage of. We've mentioned these Roth conversions. So again, most people, this happened with my father before we got in the business, but a very fortunate successful career. When he got done, had a rather sizable IRA that he was going to have to live the rest of his life on, but what he totally missed throughout that entire period of time, or even the period of time when he stopped working was a lower tax bracket where he could've been converting that IRA to Roth IRA, giving us more flexibility now to minimize his tax rate essentially. And at some point he's going to hit an age where the government actually makes him now take these required minimum distributions. And we lose all control of tax rate at that time. So this isn't something that you just pay attention to later in life, right? This is something that if you start early and it's never too late to get started, but if you start early, it can just have dramatic results over time. The other big thing I always think about in this and sad thing that we always see is the charitable side. People have such great intentions, especially people with means, and they want to help other people. And oftentimes we just see people giving cash and it just eats at me. It kind of kills me actually, because it's just money. It's wasted impact at the end of the day. And if that's really important to you, there are really easy ways to go about this. And one of the biggest ones is gifting appreciated securities or assets. It doesn't have to be a stock. It could be a piece of real estate, et cetera. But what you're doing is by gifting that asset to a charitable organization, you never have to pay the tax on the gain of that contribution, which is absolutely massive. The entity that you're giving it to doesn't have to either because they're a nonprofit organization. So the impact that you're picking up there is pretty dramatic and there are different ways to even make sure that if it's a small charity, maybe they can't accept those types of assets. There are other tools that we can use for that.
Justin Dyer (11:54): Oh yeah, there are other tools. And if there is substantial charitable intent and substantial wealth donor advised fund is a great efficient platform. But even if there's really, really intense charitable intent, a foundation might make sense. Sometimes it doesn't. Actually most of the time a donor advised fund accomplishes the vast majority of what you might want to do. But a foundation starts to make a lot of sense where you can handle assets that are a little bit more esoteric, a little bit more illiquid. And the foundation itself is the vehicle that deals with the complexity. And then you pass through the donation to the smaller charity that you're interested in.
Brandon Averill (12:36): And I think at the end of the day, we'll kind of wrap up this section. We threw a bunch at you here, ideas. And I know we probably talked a little faster because we get excited around this stuff. But the end of the day, the big message is you want your team to be really focused on helping you to minimize taxes. And there are a lot of ways to go about it. There's a lot of flexibility, a lot of opportunity when you're in that kind of ultra high net worth, or even in a high net worth type position. So you want to be focused on those strategies and then it really all bleeds over right into that investment portfolio. And we're going to kick off probably in our next podcast to how to go about investing that portfolio based upon your situation, based on you being a high net worth individual, how do we use asset location? What are the different types of assets that we put towards your priorities, your financial structure? Why is that so important, et cetera.
Justin Dyer (13:32): And also, a thread that goes through all this as well is utilizing intergenerational transfer of wealth. It applies to everything we've really talked about and especially the investment side. And we'll get into that more.
Brandon Averill (13:45): Cool. So we're going to close out for today. As usual, give me a text 602-704-5574. We love hearing from you guys, getting these comments. Hopefully we're addressing the questions that are being asked that we're getting on there. So shoot me a text. Would love to connect with you. And until next time own your wealth, make an impact and always be a pro.