Winning by Not Losing: Year-End Tax Management for the High-Net-Worth Client

“Rule number one: never lose money. Rule number two: never forget rule number one.”

Warren Buffett may or may not have had taxes in mind when he uttered this quotable phrase, but proactive tax planning is one of the most important things a financial advisor can do to help clients follow Mr. Buffett’s number-one rule. When advising high-net-worth clients with robust retirement assets of at least $1 million or more, it’s more important to focus on protecting wealth from losses – including substantial expenses like taxes –than chasing returns.

High-net-worth clients, particularly those approaching retirement, have “already won the game.” They have successfully built sufficient wealth to maintain their standards of living and achieve their financial goals. Taxes can be the single biggest investment expense they will ever face. What else is going to cost 40% or 50% of their income every single year? Understanding how to navigate the tax landscape – and being perceived by clients as an expert in this area – is a differentiator for any advisory firm. Advisors who do not educate clients on managing taxes, or find a qualified partner to fulfill this role, should expect to lose business to one that does.

While tax planning should be a top priority throughout the course of the year, there are important opportunities for you to consider at year end. Now is the time to reduce your clients’ current tax obligations and develop a strategy for managing taxes over the next 12 months to protect more of the financial assets they worked so hard to achieve.

The Benefits of Tax-Deferral: One way to reduce tax expenses is to achieve more “tax diversification”—diversifying between different tax rates, different types of taxes, and when to pay them. Managing clients’ portfolios within a tax-deferred vehicle like a qualified plan or a low-cost variable annuity is a simple solution. Many advisors labor under the misconception that the cost of variable annuities is too high. But today there are low-cost, no-load VAs designed specifically to provide clients with more tax deferral—without commissions, excessive asset-based fees and complicated insurance guarantees. The fees for today’s low-cost VAs are a very small price to pay when compared with the tax savings and additional accumulation achieved over many years of tax-deferred compounding.

Asset Location for Tactical and Alternative Strategies: It is critical to preserve wealth by avoiding market losses. Consider that an investor who makes only 30 percent of the S&P 500’s total market gains—but can avoid all of the losses—will still outperform the market overall.

Advisors can actively manage clients’ assets to protect against market downturns through a process we call unconstrained investing.  Aim to invest at least one third of clients’ portfolios in tactically managed assets uncorrelated to the traditional stock and bond markets. Seek alternative investments that can mitigate down-market risks and also generate alpha. While finding managers who can do both are rare—it is well worth the added due diligence.

But tactical management and alternative strategies can be tax-inefficient due to high turnover and short term capital gains.  So “locate” these strategies in a tax-deferred vehicle, to preserve all of the upside without any tax drag. Asset location lets you manage the way you want, protect wealth, make more money—and you don’t kill your client with taxes.

Taking advantage of tax-deferred investing vehicles and using asset location to optimize tactical management and alternative strategies are two of the most important steps advisors can take to manage taxes and preserve wealth. Other tax considerations that are relevant to high-net-worth, especially at year end, include the following:

  • Health Care Surtax: Be especially proactive this year. It’s the number-one new challenge. High-net-worth clients—or anybody earning over $200,000 a year—is subject to the surtax. And the costs add up. As an example, if a client lives in the state of California, which has the second highest capital gains tax rate in the world, when including the surtax of 3.8% you could actually pay an effective combined state and federal capital gains tax rate of 33%. Using tax deferral for capital gains is a meaningful way to mitigate this issue, as long as it’s a low-cost, no-load tax-deferred vehicle.
  • Tax-Loss Harvesting: Leverage tax-loss harvesting to achieve tax alpha, especially at year-end.  This is another approach to offset capital gains and preserve wealth, effectively increasing the rate of return on a portfolio between one and four percent.
  • Roth Conversions: Resist the temptation to do a Roth conversion before retirement. It could cause “bracket creep” by moving clients into a higher tax bracket. A Roth IRA can be an important tax-free source of income for clients in later years—and they can save more on taxes by waiting until retirement to do conversions, when they will most likely be in a lower bracket.
  • Defined Benefit & Pension Plans: Many high-net-worth clients built their wealth through a successful business. And one of the best tax planning solutions for business owners at closely-held companies is creating a good pension plan. You help clients put away hundreds of thousands of dollars, reduce taxes, and fund retirement—all in one vehicle. And it is asset-protected—protected from any personal liability—which is particularly beneficial to clients in high-risk professions.The competition for high-net-worth clients continues to increase. And to win this business, it is more important than ever to differentiate yourself from the pack. Demonstrating your expertise in tax planning—and putting it to work to protect clients’ wealth from the single biggest expense they can face—should be a top priority all year long, and especially at year-end. Using simple effective tools like tax deferral and low-cost no-load VAs can help clients achieve tax-diversification, optimize the performance of tactical and alternative strategies, and mitigate the impact of capital gains. Your clients may not be as flush with cash—or as eager to pay taxes—as Warren Buffet, but they will certainly appreciate your dedication and expertise to help them follow his number one rule.
Julie Reyes

Chief Financial Officer, Chief Compliance Officer

Julie Reyes is Chief Financial Officer and Chief Compliance Officer with Reyes Financial Architecture, Inc., a Registered Investment Advisory Firm specializing in portfolio risk management strategies, retirement income distribution and generational wealth planning. Julie is a Certified Public Accountant (Inactive) and a California Real Estate Broker. She also holds multiple licenses in the insurance and financial services fields. Julie graduated from Pennsylvania State University, with distinguished honors in 1997 and began her career with Price Waterhouse, LLP that year specializing in tax and audit. She became a California Real Estate Broker in 2002. Julie has worked with David and Reyes Financial Architecture since the company’s inception, and uses her financial background and expertise to help a wide range of clients protect their assets, minimize their tax liabilities and maximize their cash flow.

David Reyes

David Reyes is the Founder of Reyes Financial Architecture, Inc., a Registered Investment Advisory Firm specializing in portfolio risk managed strategies, retirement income distribution planning and social security planning. David works in collaboration with CPA’s, attorneys and other money managers to ensure that all planning is not only implemented but also integrated. This collaborative team approach seeks to ensure the highest probability of success.

David has been an advisor for over 20 years and holds multiple licenses and registrations in the financial, real estate, and insurance fields. David is featured in many magazines such as “Kiplinger Personal Finance Magazine,” “Boomer Market Advisor,” and is co-author of four books on estate and retirement planning. David’s latest book “The Little Red Book of Retirement” has recently been released. Currently David is working on a new book entitled, “Momma’s Secret Recipe to a Successful Retirement” with Jack Canfield. David advises many professional and public groups including CPA’s and Attorneys on retirement, taxes, estate planning, and asset protection. David is also the host of “The Retirement Architect Radio” heard every Saturday on 1210 AM KPRZ.

David is a distinguished graduate from UCLA’s Personal Financial Planning program and is a graduate of e Wharton Business School in their Retirement Income Planning Certification program. David has also been named 2015 Advisor of the Year by the National Social Security Association (NSSA) for his advocacy to educate retirees on maximizing their retirement income.

David and Julie have been blessed with three wonderful children, Morgan, Taylor and young David Reyes, III. David’s hobbies include Tennis, Church fellowship and spending time with his family.