Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 347

Top three ways an SMA helps optimise tax

There are few free lunches in investing, so any reward from reducing a tax burden is worth the effort. Financial advisers are increasingly presenting a more tax-effective investment solution to clients as part of their value proposition. The challenge is making sure everyone understands the opportunity.

In this article, we examine how tax optimisation can work using Separately Managed Accounts (SMAs). 

1. Avoid tax inheritance

Investors should avoid the inheritance of a capital gains liability. The chart above shows a hypothetical increase in a managed fund’s unit price over a period that begins when a fund manager buys a stock into that fund, and when it sells that same stock. In the middle of that period, the investor buys units in that fund. The price of that unit has inflated since the stock was originally bought, because it includes the accrued capital gain.

The investor has no choice but to buy into that gain if they want to invest in the fund, even though they were not invested during that initial period. Investors have inherited a capital gain liability. Of course, for the sake of simplicity we have made very simple assumptions, but the concept remains.

For completeness, it should also be noted the opposite is true. If a fund is carrying a capital loss, then the investor can inherit those losses and potentially reduce taxable income, although that is not typically the objective of investing.

The following chart shows what happens with an SMA.

With an SMA, the investor has beneficial ownership of the shares in a portfolio, and that makes all the difference in terms of the tax burden for an individual investor.

If we assume an investment on the same day through the period as in the previous example, the capital gain begins from the day of investment, and not the start of the period. The managed account structure means investors are buying shares in their own name, rather than units in a fund carrying capital gains. They will avoid inheriting a capital gains liability. All other things equal, the tax burden should be lower.

2. In specie transfers

Another way to optimise tax is to transfer stock holdings into the SMA via an in specie transfer, which saves selling down assets and avoids a capital gains liability even before the new investing takes place.

In the example above, an investor holding ANZ moves their investment into an SMA which also holds ANZ alongside other stocks. The key point here is through a transfer, the amount of selling is minimised through the transition into the SMA.

The opposite also works. An investor moving out of an SMA may decide to keep ANZ and sell out of the rest. That may reduce the tax burden on the way out.

Logistically, the ‘in specie’ stock transfer is typically nominated during the platform application process. The adviser (on behalf of the client) will nominate where in specie transfers apply, saving the investor any avoidable capital gains.

And by avoiding the trade, the investor also saves on brokerage costs. 

This is the advantage of having beneficial ownership of shares. The same outcome is generally not possible with managed funds.

3. Manage individual holdings

As a beneficial owner of stocks, SMAs also allow investors to manage their holdings in a way that optimises their personal tax position. An investor can elect to hold or sell parcels of stock depending on their overall tax position. For example, a gain on one parcel may be used to offset a loss on another, and so on. This technique of splicing individual parcels is generally not available in a managed fund arrangement.

Managed funds have their benefits too

While the examples above highlight some examples of tax advantages of SMA over a managed fund, there are still plenty of reasons a managed fund arrangement may be suitable for other investors.

For example, there are more investment options available in the managed fund space, especially if the investor has a specific portfolio need such as in an illiquid investment or a low-risk equity income strategy. Many of these are not offered in an SMA.

 

Andrew Stanley is Head of Australian Equities at Ralton Asset Management. This article is general information and does not consider the circumstances of any investor, and SMAs are usually available only through a financial adviser.

 

RELATED ARTICLES

How a carer inherited an estate

banner

Most viewed in recent weeks

Why we’re not buying the market yet

The Australian market bounced back last Friday (13th) and Monday (16th) tempting analysts to call the bottom of the coronavirus scare. This is too early as the impact on companies is not yet evident.

Drawdown reductions needed for retirees - UPDATED POLICY

During the GFC, in the face of rapid falls in super balances, the minimum drawdowns required for pensions were reduced by 50% to help preserve overall retirement savings. It's time for a repeat.

What are the possible economic effects of COVID-19 on the world economy?

In a widely-quoted scenario using estimated attack and fatality rates of coronavirus, about 0.07% of the population of the US dies. That's about 230,000 people, which the market is not ready for.

Note to Australia: be more French in the COVID-19 war

Andrew Baker is well-known as a superannuation consultant. Now working in the UK, he was caught in France with his family and is in lockdown. He worries Australian policy was too slow.

Optimism among forecasts of the COVID-19 peak

This detailed analysis of infections, deaths, drugs and vaccines includes an optimistic scenario: perhaps US and Australian infection numbers will peak in early to mid-April with a decline after.

How stock markets recover and the perils of timing markets

Investors who try to time buying and selling shares risk missing the strongly positive days which drive good performance, while over the long term, stock markets will recover from price falls.

Latest Updates

Economy

How $200 billion is magically created

Australia is in a relatively good position to borrow $200 billion, with the RBA using printed money to buy bonds in the market. The long-term consequences are better than the alternative.

Investment strategies

Howard Marks' latest on 'Which way now?'

Howard Marks is the largest investor in the world in distressed securities. What does he think after checking the virus positives and negatives, and how much has he changed his mind in only a few days?

Latest from Morningstar

Four stages of a typical bear market - but is this typical?

Bear markets caused by recession fears follow a pattern, but we have never seen anything like coronavirus. If financial stimulus and medicine prove ineffective, all bets are off. 

Economy

Small business in path of COVID-19 tsunami

The turning point in this crisis will be when the number of new COVID-19 cases starts to decrease. Until then, can we mitigate the damage to businesses and the economy so that we can snap back?

Investment strategies

Why technology stocks are good for the future

Over the long term, the technology sector has a vital role to make the essential transition to a more sustainable global economy and a cleaner planet. We highlight a few names with strong prospects.

Sponsors

Alliances

© 2020 Morningstar, Inc. All rights reserved.

Disclaimer
The data, research and opinions provided here are for information purposes; are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. Morningstar, its affiliates, and third party content providers are not responsible for any investment decisions, damages or losses resulting from, or related to, the data and analyses or their use.
Any general advice or class service prepared by Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892) and/or Morningstar Research Ltd, subsidiaries of Morningstar, Inc, has been prepared by without reference to your objectives, financial situation or needs. Refer to our Financial Services Guide (FSG) for more information. You should consider the advice in light of these matters and if applicable, the relevant Product Disclosure Statement before making any decision to invest. Past performance does not necessarily indicate a financial product’s future performance. To obtain advice tailored to your situation, contact a professional financial adviser. Articles are current as at date of publication.
This website contains information and opinions provided by third parties. Inclusion of this information does not necessarily represent Morningstar’s positions, strategies or opinions and should not be considered an endorsement by Morningstar.