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By David GordonDirector, Eaton Vance Advisor Institute

There is no denying the impact taxes can have on a client's ability to achieve financial goals. Taxes can almost act like a "fee" the government charges that plays a regular and recurring part in reducing the investment returns clients actually receive. Advisors cannot simply cross their fingers and hope somebody else will provide clients with tax advice that aligns with their investment strategies. Advisors seeking differentiation need to step into the tax arena and become After-Tax Advisors.

The first rule of thumb for understanding how taxation affects individual investors is:

"Taxes can be a client's easiest investment 'fee' to reduce."

The 'fee' Uncle Sam charges

No advisor is a stranger to the pressures of fee compression. Advertising and the media may convince some clients that high advisory and management fees are the biggest drain on investment returns. For many clients though, the tax "fee" is much larger and easier to reduce.

Suppose, for example, that a couple (married filing jointly) has taxable income of $500,000. For simplicity, let's assume they live in a state without state income taxes, such as Florida. A visit to the Eaton Vance Parametric Investment Tax Calculator shows that withdrawals from this couple's qualified retirement plan would be subject to a 35% income tax.1 If that withdrawal also happens to be a 5% required minimum distribution, the tax this couple pays is 1.75% of their total qualified plan value (35% x 5%). Depending on their asset allocation, that tax fee probably rivals any investment management fees they pay.

Reducing the 'fee' on investment income

Advisors who aren't tax professionals can still provide valuable insight into how taxes affect investment returns. Just ask yourself these two questions:

  1. Do your clients understand that long-term capital gains are taxed differently than short-term capital gains?
  2. Do your clients appreciate the difference between nonqualified dividend income and qualified dividend income?

By helping clients make better choices, you may be able to improve their after-tax returns by reducing the tax "fee" they pay.

Bottom line: Taxes matter. The After-Tax Advisor® helps identify opportunities to help clients grow tax-smart wealth throughout the year.

tax forward