Location optimization can be a great tool in portfolio management. Location optimization, in basic terms, is locating specific types of investments in specific types of accounts to minimize taxes. The tax reduction "prize" is huge. IRAs can be used to postpone ordinary tax on current income. Taxable accounts can achieve tax deferral (until a sale) at capital gain rates or tax avoidance (basis step-up at death). Roth IRAs can maximize tax-free compounding on high return investments.
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To apply location optimization, you and the client must want to reduce taxes. This is a no-brainer, right? It should be, but it's not. There are three obstacles:
- Client perception
- Advisor-client communication
- Advisor workload
Clients can have difficulty with location optimization. This is because the client's individual accounts will not each hold the same investments. Therefore, each account will perform differently than the others. Will your client be ok with her IRA showing a lower performance number than her taxable account? This can be a very real concern for many clients.
Because of the performance disparity between accounts, the advisor must report returns at the portfolio level and train clients to only look at portfolio returns and not individual account level returns. This takes time and patience to change client perspectives and can only be achieved by communicating the significant benefits from location optimization.
Finally, advisors must be willing to do the work (and invest in the software necessary) to implement location optimization.
Is the reward knowing that the clients will be better served? Can providing this service actually increase your business? The answer is both. Location optimization can save your clients taxes and differentiate you from the competition. You just need to overcome the obstacles.