5 tax planning challenges facing financial advisors

The large wealth and asset management firms that must recruit and retain financial advisors to keep their dominant positions will need to bulk up their tax planning technology, a study said.

Otherwise, their “insufficient support for tax optimization” will hamper their comprehensive services, and firms that “cannot make significant headway in these efforts could find themselves at risk of reduced inflows and advisor attrition,” Cerulli Associates concluded in a recent report. As part of the study, the research and consulting firm polled the wealth and asset management firms that are the largest providers of so-called managed accounts — which one of the authors of the study, Cerulli Senior Director of Advice Relationships Scott Smith, defined in an interview as any “fiduciary advisor relationship at a traditional wealth management firm.”

Despite there being no shortage of research about the importance to advisors and clients, the providers admitted they have a great deal of work to do in the automation of pivotal areas of tax planning, such as Social Security, data and account aggregation, and portfolio management. The firms are certainly investing, as Smith cited developments such as Edward Jones’ deal to acquire the tax overlay arm of Natixis and other frequent M&A transactions by large firms. But an edge in tax-focused investing will prove to be “a bigger and bigger source of differentiation” as firms aim for advisors to be able to reduce payments to Uncle Sam and various states across several accounts and types of holdings in clients’ households, Smith said.

“Everyone probably could be better. Overall, that household approach is probably two steps beyond what most firms are at right now,” he said. “There are going to be incremental steps for every major broker-dealer or wealth manager in the space.”

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Portfolio complexity

For instance, an earlier Cerulli study and other industry experts have pointed out the potential for Section 351 conversions of ETFs to defer capital gains and their accompanying taxes for diversified but highly appreciated stock portfolios that might otherwise be stuck. The Securities and Exchange Commission’s 2019 ETF rule modernized the guidelines in a way that clarified the regulations governing that strategy, according to Brittany Christensen, a senior vice president and head of business development at Tidal Financial Group, which works with issuers and sponsors launching funds. But the rise of separately managed accounts and the many firms that service them in some way are adding complexity to the adoption, she said.

“Where it gets more complicated is if you look at a bigger suite of SMA accounts, for example, and that gets incredibly complicated if you have several custodians,” Christensen said. “You’re really trying to get all of those details pinned down and just make sure that you have the right lawyers’ eyes on all of them.”

Even though those technical hurdles remain in advisors’ paths, and IRS rules in general tend to cause clients’ eyes to glaze over, customers do want to discuss tax strategies with their advisors, according Liam Hanlon, the head of insights at Jump, a wealth management technology firm using AI for applications like its meeting assistant. Tax-focused conversations between advisors and their clients increased around the passage of the One Big Beautiful Bill Act, Hanlon found in an analysis of meeting transcripts and summaries.

Taxes are always a “good area to cover in a prospecting call, regardless of the macroeconomic environment,” Hanlon said, adding an important caveat.

“Tax planning is the topic that is least brought up by clients. It’s an advisor-initiated discussion,” Hanlon said. “Tax planning always inspires the most questions once it is brought up. If the advisor doesn’t initiate it, the conversation is usually not going to happen. But clients have questions.”

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Acknowledged shortcomings

And if advisors don’t have the technical resources to provide answers, that prospect may well walk out the door to a firm that does have them at the ready.

Advisors and the wealth and asset management firms they work with must develop more tools and strategies to treat their clients as “a unified managed household” that is investing and planning for retirement and future generations with the full tax ramifications in mind, according to Cerulli. Acquisitions such as JPMorgan Chase’s purchase of 55ip in 2020 and SEI’s deal to buy LifeYield last year display how more firms are trying to do so.

But the wealth and asset management firms surveyed by Cerulli themselves recognize that they have only automated some of the many key capabilities that could lower clients’ taxes. 

When asked to evaluate the degree that their firm has automated certain tax planning strategies, 78% of managed account providers said they had rolled out that level of capability for tax-loss harvesting, and 56% said they had reached it for documentation of tax savings. But transitions (48%), withdrawals (44%), asset location optimization (36%) and Social Security implications (16%) have much lower adoption, in terms of automation tools that eliminate the need for manual processes. And that looks much different from the state of tools aimed at improving the yields on client investments, according to Cerulli.

“In contrast, over the same period, tax optimization efforts often have been relegated to secondary status due to the long, complicated, and expensive implementation processes,” the report said. “Providers and advisors had not prioritized these efforts because it was difficult to explain their benefits to clients. However, as more clients now express their interest in tax savings and platforms are seeking opportunities for differentiation, provider and advisor interest in tax optimization schema has increased substantially.”

To see the main takeaways for financial advisors and wealth and asset management firms from Cerulli’s report, scroll down the slideshow. For a look at research suggesting RIAs are in a period of “prosperous stagnation,” click here. And for a roundup of estate planning tools and strategies for financial advisors, follow this link.