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Improving SMA Investment Performance: De-Mystifying Tax Efficient Solutions

Tax-efficient investment structures are now critical for safeguarding and growing assets.

An increase in the popularity of debt-oriented funds, combined with recent changes to state income tax rates and rules limiting deductions, has led to a reduction in after-tax returns of ordinary income for high-net-worth clients of RIAs—making tax-efficient investment structures critical for safeguarding and growing assets.

Take, for example, an RIA managing a $25 million portfolio that produces high-tax ordinary income on a regular basis (such as interest income or short-term capital gains) that their client does not currently need. Assuming a 10% annual yield, a separately managed account within a life insurance policy would allow that yield to grow tax-free or, within an annuity structure, on a tax-deferred basis.

Over the past 5 years, many sophisticated RIAs dealing with clients with $10 million or more in assets have begun to incorporate insurance products into their offerings, increasing the efficiency of their investment advice. They originally turned to insurance-dedicated funds (IDFs), which offer a limited number of options and are designed to serve several investors with the same objectives.

But, larger client accounts looking for customized portfolios may require a different solution—a separately managed account (SMA) inside an insurance structure, which provides far greater transparency and control than an IDF.

As more and more RIAs become interested in SMAs within an institutionally-priced annuity or life insurance structure, they often express confusion regarding how to access and implement these products for their clients. These RIAs have large clients for whom a private placement insurance policy would make sense, but they don’t want to deal with the hassle of setting up a customized account.

This complexity can be greatly reduced by finding an insurance provider that has the expertise, experience and relationships to act as a “one-stop shop,” helping with both the regulatory aspects and execution of these products through partnerships with accounting and law firms. The long-term tax benefits of moving an SMA into an insurance structure are enormous.

RIAs can feel comfortable that, unlike more esoteric tax planning strategies, there are no underlying tax issues or risks with private placement SMAs. Investor control and diversification requirements for these accounts are also now more clearly defined than they were several years ago, meaning there won’t be any regulatory issues with a properly-designed product. In addition, as the client has already given discretionary control to the RIA, a private placement SMA meets the requirement for investor control while allowing the money to be managed more efficiently.

To set up a private placement SMA, RIAs should first determine which product is appropriate and in their client’s best interests by speaking with an insurance carrier that specializes in insurance solutions for HNW individuals. They should then inquire about the process and ensure that the insurance provider has strong relationships with a recognized law firm and accounting company to develop the SMA with minimum hassle.

Given that the complexity of these products has been greatly reduced in recent years, RIAs should feel comfortable in looking at SMAs as a potential way to maximize the tax-efficiency of a client’s investments when appropriate.

Perry Lerner is Co-Founder and CEO of Crown Global Insurance Group, LLC.

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