Tax-Efficient Investment Management 2006-2014, A Case Study

This paper highlights the importance of active tax management of investment portfolios, using the results of an actual Ballentine Partners’ client as a case study.  While the strategies and results described are real and verifiable, other details regarding the client have been altered to protect confidentiality.

During the period covered by this study, we were able to add approximately $18.8 million of value for a $300 million portfolio (inclusive of a concentrated stock holding) through the combined impact of (1) strategically locating assets to save gift tax, estate tax, and generation skipping tax and (2) active tax management of the portfolio.

Active tax management means managing a portfolio to achieve an optimal net return after all taxes and fees.  In any given period, it is likely that portions of a diversified investment portfolio will experience gains while other portions will experience losses.  That is the nature of a well-designed diversified portfolio – the returns of the portfolio components are intended to be uncorrelated (some investments will have positive performance while others will have negative performance over the same time period), while the overall portfolio is expected to produce gains.  The income tax code allows an investor to offset realized losses against gains that are realized later.  In other words, it is possible to “bank” losses against future gains to protect those gains from being subject to capital gain tax, however, doing this is not easy.  Active tax management requires a high level of attention and skill on the part of the portfolio manager.  It also requires collecting and analyzing information about the client’s tax situation throughout the year.  In order to do this, we had to create our own systems and, as far as we know, no other wealth manager has attempted that.

In this example, we were able to effectively zero out all of the clients’ income taxes through active management.  From 2006-2014, the pre-tax and after-tax return portfolio returns were essentially the same.  In fact, for most of the period the clients’ after-tax return slightly exceeded their pre-tax return when the present value of the deferred tax-savings available to them is taken into account.

Most private investors are aware of the importance of strategic asset allocation, but few are aware of strategic asset location as a wealth-creation opportunity.  Strategic asset location involves making tactical decisions about ownership structures and aligning various types of assets with those ownership structures to achieve outstanding investment results after-tax across generations of a family.  In this type of planning, income taxes, gift tax, estate tax, and generation-skipping tax must all be taken into account.

In this case, our asset location strategies allowed the clients to move $27.3 million of assets out of their estate, which saved the family about $16.4 million in eventual estate taxes, incurring no gift tax to achieve this result.  The clients held a concentrated position in a single stock which we utilized to fund a series of Grantor Trusts.  They also used a combination of cash and securities to fund an education trust for future generations and a trust for the benefit of grandchildren.  Using the annual gift exemption amounts, the clients made outright gifts to certain individuals and assisted with the funding of the education trust and grandchildren’s trust.

Keep in mind that this analysis concerns just one client and the results described here are unique to that client.  The selection of this particular client was based on the following factors: (1) the author of this study wanted to do the analysis and found the time to do it and (2) the author was able to assemble all of the data for this client necessary to perform this comprehensive analysis.  Selection of this client was not based on the client’s net investment returns.  The analysis is based on the clients’ personal portfolio and trusts on which the clients pay income taxes.  We excluded all other family entities.  We also excluded private investments and the clients’ concentrated stock position.

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