Advisor Insights

7 Ways Software Helps Clients Manage Taxes

Sheryl Rowling

Using technology to become more efficient is great from a practice-management standpoint. But wouldn’t it be even better if the technology saved tax dollars for your clients also?

It seems like the holy grail—save time for you and money for your clients. Yet it’s out there. You just have to take advantage of the tools available. Investment-management software includes three basic elements:

1 Portfolio Accounting—software (like Morningstar Office) that tracks each client’s investment holdings, dividends, interest, realized gains/losses, unrealized gains/losses, returns, etc.

2 Account Aggregation—software (like ByAllAccounts) that retrieves financial data on investments held outside of an advisor’s direct management (such as 401(k)s and annuities) and integrates that data directly into the portfolio accounting software.

3 Rebalancing—software (like Morningstar Total Rebalance Expert) that monitors clients’ accounts and calculates appropriate tax-efficient trades for rebalancing, cash needs, and tax-motivated transactions (such as tax-loss harvesting, capital-gain-distribution avoidance, and location optimization).

Advisors are expected to make sound investment recommendations, track their clients’ investments, rebalance when necessary, and provide periodic reports.

Using robust investment management software can help advisors exceed client expectations by lowering their tax liabilities and leave their competition—and the robos—in the dust.

Tax savings can be classified into four different categories:

  1. Current Permanent (Avoiding short-term gains)
  2. Current Temporary (Tax-loss harvesting)
  3. Deferred Permanent (Holding appreciating assets in taxable account)
  4. Deferred Temporary (Holding bonds in retirement account— future years)

Current tax savings means that the client will receive an immediate tax benefit, while deferred tax savings will be realized at some point in the future. Permanent tax savings will never be repaid, while temporary tax savings might require repayment down the road.

The three types of software—portfolio accounting, account aggregation, and rebalancing—can help create all four of the different types of tax savings.

Here are seven ways that bumping up your software investment can wow your clients:

1 Manage at the Portfolio Level
Many advisors and most robo-advisors manage on an account-by-account basis. This means that a “full pie” of asset classes is contained in each account.

Managing at the portfolio level reduces the number of transactions (rebalancing won’t require you to buy, say, more global real estate in every account or sell emerging-markets equity in every account) and allows for location optimization (holding appreciating investments in taxable accounts, income-producing investments in retirement accounts, and high-return investments in Roth IRAs) to minimize taxes.

I explain it to clients this way:

“We hold ordinary income-producing investments in retirement accounts because, if held in taxable accounts, the interest income is taxable each year. If bonds are held in retirement accounts, the tax is deferred. Eventually when you take the money out, it will be subject to ordinary tax—which would be applicable in a taxable account anyway. By holding bonds in retirement accounts, you at least get a compounding benefit.

“We hold appreciating assets in the taxable account. Because appreciation isn’t taxed until investments are sold, the investments are essentially tax-deferred anyway. However, when you sell, you will pay capital gains rates on the gains. If you hold appreciating investments in a retirement account, you will eventually pay ordinary tax. That would be like telling the IRS you’re OK with paying twice as much tax.

“Finally, we hold high-return/high-risk investments in the Roth IRA. This is because the Roth IRA never pays tax, and we want the biggest bang for our buck!”

2 Manage 401(k)s
Let’s face it: Employees don’t pay attention to their 401(k) investment strategy. They might ask you to review their allocations every year or two, but they generally feel lost when it comes to employer plans.

By integrating clients’ 401(k)s with their directly managed accounts, you can provide ongoing professional management of funds that were previously largely ignored.

From my experience, clients are more than happy to pay more management fees just for the sense of relief!

There is also a huge tax benefit to this: By managing at the portfolio level, the advisor has more opportunities for location optimization—meaning more fixed-income investments can be allocated to the 401(k), leaving the directly managed portfolio available for appreciating investments.

3 Save on Current Taxes
Rebalancing software can prevent unnecessary tax hits by avoiding short-term gains, choosing high basis lots on sales, capturing tax-loss harvesting opportunities, and avoiding capital gains distributions at year-end.

Although all of these strategies merely postpone tax, they are likely the strategies clients will notice because they directly affect current tax bills. The temporary savings won’t necessarily need to be repaid if 1) the advisor continues to manage taxes efficiently and 2) the investments are held until the client is in a lower tax bracket or passes away.

4 Great Benefits for Charitable Contributions
Using portfolio-accounting or rebalancing software can identify holdings with long-term appreciation.

Clients who want to make donations can contribute the most highly appreciated shares to their favorite charities (or donor-advised funds) rather than cash. They get the full deduction at fair market value without paying tax on the gain.

5 Be Instantly Responsive to Tax-Loss Harvesting Opportunities
Rebalancing software like Morningstar Total Rebalance Expert can create tax-loss harvesting trades across all your clients’ accounts in minutes should a particular fund drop in value.

By setting parameters, the software can:

  • Harvest losses solely in taxable accounts.
  • Harvest losses only when the loss is material (as defined by the advisor).
  • Avoid transactions when a redemption penalty would apply.
  • Avoid transactions when a wash sale would apply.


6 Harvesting Gains
At times, it can be advantageous to harvest capital gains.

This would occur when a client is in a low tax bracket (such as the 10% or 15% brackets)—thus, subjecting recognized gains to a 0% tax rate.

Because this is a rare freebie in the tax code, advisors need to ensure that they don’t overlook an opportunity.

Again, portfolio-accounting or rebalancing software can identify appropriate transactions to take advantage of this beneficial tax strategy.

7 Avoid Capital Gains Distributions
Toward the end of each year, mutual funds distribute internally recognized capital gains to shareholders.

This phantom income must be reported on the shareholders’ tax returns even though they received no cash. Capital gains distributions are not a pleasant surprise to clients, yet most advisors can’t or don’t want to spend the time to avoid them.

Once the advisor has identified funds expecting material distributions, Morningstar Total Rebalance Expert merely needs the distribution information entered for the currently held fund and the replacement position (which should be a fund with lower or no expected capital gains distributions).

The software will create trades:

  • Solely in taxable accounts.
  • Where the net distribution savings are material (as defined by the advisor) after considering potential gains on sale.

Doing a better job for your clients doesn’t have to mean spending more time. Using the right software can help.


This article originally appeared in the December/January 2018 issue of Morningstar magazine. To learn more about Morningstar magazine, please visit our corporate website.