Transition Planning: The X Factor in Wealth Management

When it comes to selecting a wealth manager, discerning clients often prioritize a few key factors: the personal rapport and trust they share with their advisor, the allure of the firm’s investment strategies and planning capabilities, and the depth of the firm’s global resources.

These are all critical elements, but there’s one powerful factor that is frequently overlooked: a meticulously crafted transition plan.

Imagine this: you’ve spent years, perhaps decades, building a portfolio that reflects savvy financial decisions and strategic foresight. Now, you’re considering a new wealth manager to guide your assets to even greater heights. But what are the tax considerations of moving your portfolio? How will your portfolio make that journey? The transition plan is essentially the roadmap for this critical phase, and it’s an aspect that can have profound implications on your financial future.

Taxes Can Be a Sticking Point

For investors with appreciated assets, the transition process can feel like navigating a labyrinth. Embedded capital gains present a formidable challenge, and the tax considerations of moving your portfolio can be steep. In fact, some investors give up before even trying, hamstrung by concentrated positions that have appreciated over the years. They assume their best tax strategy is to stay the course, even when there is an opportunity to improve their allocation or move to a preferred wealth management firm. To top it off, many wealth managers treat this crucial phase as an afterthought—they’re often more focused on securing your mandate than on the intricacies of transitioning your assets.

Consider the questions that often go unanswered:

• What is my all-in tax cost to moving?
• Can anything be done to mitigate those costs?
• Will this be a drawn-out process that feels like a black hole?

These are not trivial concerns. The answers to these questions can significantly impact your net worth. Yet, for many investors, these questions often remain unaddressed—until it’s too late.

Does Your Manager Have a Plan?

Moving your assets shouldn’t feel like a leap of faith. The journey to your end-state allocation strategy is just as important as the destination itself, in our view. That’s why astute managers place a strong emphasis on tax-efficient transition planning, ensuring that every step is meticulously executed.

What should investors look for in a transition plan? An approach that’s proactive and quantifiable. Managers should be able to clearly pinpoint the tax cost of moving your assets and deliver a clean, tax-tailored plan customized expressly for you.

Keep in mind, this step is more than a postscript from the back office. Instead, addressing the tax considerations of moving your portfolio should be a core competency that’s discussed up front—and central to the selection of a wealth management partner. Put simply, transition planning should be a key part of a holistic offering that helps provide a sense of assurance and financial clarity.

Strike a Balance

Why is having a transition plan so valuable? Because moving to a new wealth manager often involves multiple portfolios, cashflow constraints, a ceiling on the amount of capital gains you’d like to recognize, and possible coordination with one or more charities you’d like to benefit. So, how should you think about the trade-offs involved?

Consider this four-step framework:

1. Determine your desired allocation: Start by determining your ideal portfolio, tailored to your goals and investment preferences, assuming no tax consequences.
2. Identify tax-efficient options: Aim to retain appreciated positions that fit into the new portfolio while exploring strategies for less appreciated ones.
3. Model the trade-offs: Quantify the economic impact of various choices and find a happy medium between tax costs and allocation benefits.
4. Transition thoughtfully: Confidently implement the documented plan, minimizing tax drag.

What Are Your Options?

There are many tools that can be used to make transitions more tax-efficient, such as maintaining some existing stocks and bonds in separately managed accounts, building around existing ETFs, and incorporating charitable giving strategies and/or exchange funds to efficiently diversify concentrated, appreciated positions. An astute wealth manager will pull the right levers to make transitions more efficient, give you trade-offs, and explain them.

For instance, using round numbers, a $25 embedded gain might be handled by deferring $12 in separately managed accounts, $5 in existing ETFs, shifting $3 to an exchange fund, and $3 to a donor-advised fund. On a net basis, the investor would only realize the remaining $2—a much more manageable figure (Display).

Ensuring a Smooth Transition

When selecting a wealth manager, be sure to consider the transition plan, tax costs, and end-state allocation strategy holistically. In the world of wealth management, where every decision carries significant weight, don’t overlook the importance of a well-thought-out plan that addresses the tax considerations when moving your portfolio. It’s the bridge between where you are and where you want to be, and it deserves the same level of scrutiny and expertise as any other aspect of your financial strategy.