Previously, we discussed ways to reduce your taxable income by maximizing your contributions to tax-deferred accounts like 401(k)s and SEP IRAs. This is a great tax strategy, but it’s not the only strategy for you to consider. We’d like to continue that discussion with another strategy for reducing your taxable income: switching from mutual funds to separately managed accounts (SMAs).
After all, in the end, it’s not how much you earn that matters most. What matters is how much you manage to keep.
Before we get into the tax advantages of Separately Managed Accounts, let’s define them and learn about how they’re different from Mutual Funds.
What is a Separately Managed Account?
An SMA is a portfolio of assets managed by a professional investment firm. SMAs are like mutual funds in that they are usually highly diversified investments1 (meaning they invest in many different companies), and they can have a particular focus (Large Cap, Technology, International, etc.).
SMAs are different from pooled financial vehicles like mutual funds in that each client owns each individual position in their personal account.2 When you buy into a mutual fund, you don’t have any control over which stocks are included in the fund. It’s difficult to know how diversified your portfolio is because even if you own 10 different mutual funds, each of those mutual funds could hold many of the same stocks. Also, you don’t actually hold the stocks in your own name.1
With an SMA, however, you are the holder of the stocks you own, and this is where you may have more control over your tax bill.
Potential Tax Benefits of Separately Managed Accounts
Since SMA investors hold stocks in their own names, they have more control over the taxation of their holdings. For instance, at the end of the year, new mutual fund shareholders have to pay the same amount of taxes on the same capital gains as do shareholders who have been part of the mutual fund since January 1st.1 With an SMA, investors receive personalized tax documents based on the actual trades executed for their accounts.
Also, in a mutual fund, stocks may be traded frequently, depending on market fluctuations and individual company profits and losses. Because of all of this buying and selling activity, mutual funds often incur significant capital gains. These gains are “passed along” to the investors, which can result in increased capital gains taxes for you.
Another potential tax benefit of Separately Managed Accounts is that your manager has more flexibility for offsetting capital gains with capital losses. Your financial advisor can review your taxable accounts to hunt for unrealized losses, and by harvesting those losses, you may be able to offset your gains and avoid capital gains taxes.
Work with a Wealth Manager to Reduce Your Taxable Income
If you have been investing in mutual funds as your primary strategy for saving for retirement, you may want to consider switching to an SMA. The control, flexibility, and tax benefits could make a big difference in your wealth planning strategy.
To speak with a Wealth Manager about your personal situation regarding mutual funds and SMAs, contact us at 1-800-541-7774 or contact us here. We’d be pleased to help you .
Sources:
2. Investopedia
The information presented by WrapManager, Inc. is general information only and does not represent tax or legal advice either expressed or implied. You are encouraged to seek professional tax advice for income tax questions and assistance. WrapManager, Inc. does not advise on any income tax requirements or issues.
