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Asset Location: Meaningful, Clear and Easy

by | Mar 7, 2017 | Blog | 0 comments

According to the 2015 Harris/Jefferson National Advisor Authority survey, tax management is the #2 issue of most concern for advisors in the near term (just behind retirement planning). 

The 2016 version of the same survey found that taxes were the #2 and #3 “biggest financial concerns” for the two primary investor groups in the study.  And, for the group emphasizing return as its objective, taxes were the #1 issue expected to “adversely impact the portfolio in the coming year”. 

Similarly, the 2016 US Trust study titled “Insights on Wealth and Worth” surveyed investors with a minimum of $3 million in investible wealth, and 55% said, “it’s more important to minimize the impact of taxes when making investment decisions than it is to pursue the highest possible returns regardless of the tax consequences”.

The newly released 2017 study from the prestigious CFA Institute found that “Tax planning” was the 4th most in-demand service from wealthy individuals of 13 total services (and just behind the core services of “Asset allocation” and “Financial plan creation”).  Equally important, tax planning has the biggest gap among the top five services in what’s demanded from clients and what advisors deliver.

Let’s summarize:  portfolio taxes matter to advisors and their top clients.

(For purposes of this discussion, a top client is a family with at least $2.5 million in investable wealth and an annual income greater than $450,000.)

Asset Location:  A Fundamental Tool for Delivering Tax Management Services

Asset location sits underneath any competent tax management service.  (Asset location considers the range of investments owned by an individual or family and “locates” each investment in the portfolio structure that will achieve the highest after-tax return.)  In fact, of the various tax alpha tactics an advisor employs (e.g. tax loss harvesting; income shifting; gains management, etc.), asset location offers a predictable structural path.

Unfortunately, the Scottrade 2016 RIA study found that of 11 wealth planning services, tax planning ranked 9th in an advisor’s confidence in adequately delivering it (50% of all advisors) and just ahead of the bottom two services related to healthcare planning.

Danger!  Asset Location Assumptions

When thinking of asset location, advisors consider two investment “locations”: taxable and tax-deferred portfolios. 

The core premise is to put tax inefficient investments such as fixed income, REITs, actively traded investments (e.g. hedge funds), and the like into tax-deferred portfolios expecting (hoping) that tax rates will be lower in retirement than during the working years.  The difference in tax rates should it come to pass becomes the tax alpha an advisor produces.

Buy and hold equities paying qualified dividends would sit in the taxable portfolio to avoid each dollar withdrawn from tax-deferred retirement portfolios being taxed at higher income tax rates (i.e. vs. lower capital gains and dividend tax rates).

There are two major flaws in this reasoning.

First, for these top clients, it’s often incorrect to assume that lower income tax rates will apply in retirement. As our last blog established, a wealthy client has a variety of retirement income sources that are often quite substantial. 

For example, pension payments, deferred compensation, board of director fees, consulting retainers, social security, taxable portfolio income, and required minimum distributions (from tax-deferred portfolios) quickly add up to reach the 33% tax bracket (as of 2017: $191,650 filing separately; $233,350 married filing jointly); this does not include applicable state income taxes. (Note: for a given amount of gross income, the top bracket for retired HNW clients is more easily reached because of fewer deductions than during the working years (e.g. often no mortgage interest; no dependents; capped charitable deductions; etc.).) 

Second, asset location, as currently practiced, represents a big bet on future federal and state tax policy.  Setting politics aside, expecting a decline in federal and state taxes in the face of mounting national and state debt – that grows ever faster because of pension and medical obligations – is less and less likely over time.  Simply, the size of the Baby Boom generation and its longevity demographics are fuel to the national debt fire, and increasing tax revenues is a primary method to keep the debt from swelling to an unsustainable level.

AAVUL:  The Third – and Best – Location

An ideal asset location container has these features:

  1. Tax free and not just tax deferred
  2. No age restrictions for accessing the portfolio’s value
  3. Tax-free withdrawals that don’t add to the client’s tax burden
  4. An advisor managed portfolio for ongoing wealth plan integration
  5. Flexibility to include a wide array of investment categories
  6. No limits on initial and ongoing contributions
  7. A compounding profit net of the container’s costs
This list describes advisor-applied variable universal life (AAVUL). 

While AAVUL is insurance – it comes with a valuable tax-free death benefit – it is foremost an investment portfolio.  In fact, for a given dollar contributed, nearly all dollars flow into the portfolio to earn income and gains tax free.  Even with the policy’s costs, a high-income, HNW client likely reaches breakeven on these costs in a few years and, then, earns a compounding profit thereafter.

Breaking from Bad Experiences

Most advisors have had one or more bad experiences with insurance products and their distribution model.  While these experiences may make memories, they should not block consideration of innovation.   

AAVUL represents an entirely new insurance product category that fits tightly to an advisor’s high-demand tax management services.  With AAVUL being the ideal asset location container, clients gain an advisor’s expert involvement building and managing a flexible – and tax-free – portfolio that serves as the primary wealth creation platform for decades.

Insurance Like It Should Be:  Benefits without Barriers

Advisor-Applied VUL is a vastly different – and more powerful – wealth-planning tool than your past experience may suggest.  You and your clients gain VUL’s high-value benefits but the obstacles that may have prevented you from using it in the past are stripped away.

The new Advisor-Applied VUL.
 It’s low-cost, one-step tax alpha. 

Insurance Like It Should Be

Benefits, without Barriers

You’re most familiar with retail VUL and its drawbacks:
loads; high costs; complex products; investment limitations; a difficult sales process.

Check out our PPVUL and Registered AAVUL partners’ solutions that keep VUL's benefits while removing the barriers.

Experience Advisor-Applied VUL in Action
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the many uses and benefits that PPVUL and
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