Understanding Capital Gains: Navigating The Great Wealth Transfer

“The great wealth transfer” was once a nebulous event, something that would happen at some nonspecific point in the future. No more. The “gray tsunami” is most definitely here. About 10,000 baby boomers are turning 65 every day and by 2030 every one of them will be at least that old.^* They have started to spend down their often significant nest eggs and are planning for their heirs. A staggering $105 trillion dollars is anticipated to be transferred between generations over the next 25 years.**

This inflection point has traditionally presented a challenge for advisors. Only 19% of affluent investors currently use their parents’ advisors. And of those who do, 25% are actively seeking a new provider within a year.***  But this doesn’t have to be the case. For advisors positioned to add value and differentiate their services to both generations, wealth transfers can provide opportunities to solidify relationships, and not just to retain assets but to grow them.

For investors of two different generations, their objectives likely differ, their values perhaps, and their timelines certainly. What remains ever-present is the drag of taxes and therefore an advisor’s ability to improve after-tax outcomes for both.

Adding Value for Retirees

After a lifetime of investing, saving and compounding, embedded capital gains in taxable portfolios can be sizeable. Tax-smart spending, an important part of a broader tax-aware approach to portfolio management, can help retirees reduce the impact of capital gains when withdrawing from portfolios to fund retirement expenses.  By selling securities with gains in combination with those with losses, the burden of capital gains on retirees can be reduced.

A common misperception remains: Because equity markets tend to rise over time, it’s thought that portfolio losses erode quickly and completely. It would then follow that tax-smart spending adds little value. In reality, losses can and do persist, especially at the security level. And even for investors with long holding periods, reinvested dividends and more recent investments provide new opportunities to leverage losses and therefore to reduce realized gains.

While selling based, in part, on cost basis, has the potential to improve retirement income by lowering taxes, it also has the potential to skew the portfolio towards those positions with higher embedded gains. 55ip’s platform monitors not just cost basis for each tax lot, but also the portfolio’s alignment with its benchmark. Advisors and their clients are firmly in charge of the balance between minimizing tax liability and maximizing portfolio alignment. As part of a holistic tax strategy that includes charitable giving and trusts, tax-smart spending has the potential to benefit this generation – and the next one as well.

Adding Value for the Next Generation

As we’ve said, the chance of an inheritor leaving their parent’s advisor is significant – and for good reason. Our parents’ needs, our needs, and indeed our children’s needs can differ in many ways. How then do advisors demonstrate their worth to the next generation? Well, in the same way that they always do – by understanding and addressing their specific situation, values and goals.

As we know, inheritors benefit from a step up in basis. The tax value of inherited assets is adjusted to their market value at the time of inheritance, so any gains that may have accrued up to that point are waived. This presents an opportunity for advisors to reposition portfolios to align with the recipient’s goals, which can often include reducing outsized single stock positions. But it also gives the advisor the opportunity to manage this newly positioned portfolio in a tax-smart manner going forward – taking advantage of tax-loss harvesting opportunities as they continually emerge.  The utilization of tax-tech to enhance portfolio outcomes is a powerful, continuous differentiator with the potential to add value over time. We’ve written in detail about the benefits of tax smart management and the (surprising to some) persistence of harvesting opportunities. 

The 55ip Difference: Adding Value for Advisors

Taking a tax-smart approach to managing cross-generational wealth can add value to clients and create impactful differentiation for advisors – when it’s most needed.

Today, technology enables investors and their advisors to reduce the gap between what portfolios make and what investors keep. As baby boomers retire and money in motion increases, it’s more important than ever for advisors to be able to differentiate their services and help their clients mitigate the impact of taxes across markets and market cycles, across strategies and generations. 55ip is committed to being the industry standard for personalized, tax-smart investing.  That’s why, at key inflection points and beyond, we help advisors position their practices for generational retention and growth.  

* 2020 U.S. Census: https://www.census.gov/library/stories/2019/12/by-2030-all-baby-boomers-will-be-age-65-or-older.html

** Bloomberg, Dec 5, 2024: https://www.bnnbloomberg.ca/business/company-news/2024/12/05/a-105-trillion-inheritance-windfall-is-on-the-way-for-us-heirs/

***ThinkAdvisor November 14, 2023: https://www.thinkadvisor.com/2023/11/14/only-19-of-investors-work-with-their-parents-advisor-cerulli/

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