Tax-Aware Investing Landscape

Why Tax Management Deserves a Closer Look

Over the past decade, wealth management has seen steady innovation, but few areas have advanced as meaningfully as tax management. What’s changed is the level of precision now available. Sophisticated tax management is no longer limited to the planning level. It now takes place at the portfolio level, often daily, using lot‑level data to harvest losses, minimize gains, and align investment activity with each client’s tax situation. When done well, it can deliver meaningful, measurable value.

Despite this shift, many portfolios remain inefficient. In the past, asset location and year‑end loss harvesting were considered sufficient. Lot‑level, client‑specific tax management was not feasible. Today, with modern tools, advisors can run tax-aware portfolios tailored to a client’s tax profile, including daily tax-loss harvesting.

For many, tax management is no longer optional. It’s a core part of how they serve and retain their clients, attempt to improve outcomes, and differentiate. The good news is that advisors now have more choices than ever. Whether through software platforms or outsourced overlay managers, there are clear, accessible paths to integrating tax management into a practice.

Understanding the Tax Management Funnel

Tax management operates on a spectrum, and surface‑level actions rarely capture its full potential. We view tax management as a four‑layer funnel. It begins with broad strategic decisions and narrows to highly specific daily portfolio activities. Each layer builds on the one before it, forming a complete framework for potentially reducing a client’s tax burden.

Layer 1: Account Selection – Where Capital Lives

The most foundational level of tax management is choosing the right types of accounts for a client’s assets.

Advisors often begin by helping clients fund tax‑advantaged accounts such as IRAs, 401ks, and 529s. These accounts offer tax deferral or exemption and serve as the first line of defense against unnecessary tax exposure.

Layer 2: Asset Location – Matching Investment Type to Account Type

Once assets are spread across account types, the next decision is what to place where.

Tax‑inefficient investments, such as taxable bonds, hedge funds, or high‑turnover active strategies, are generally better suited for tax‑deferred or tax‑exempt accounts. More tax‑efficient assets, such as municipal bonds or low‑turnover equity strategies, tend to fit better in taxable accounts.

Getting this step right can materially reduce tax drag. And while it’s often labeled as “table stakes,” it’s seemingly still not consistently implemented across advisory practices.

Layer 3: Product Selection – The Structure Behind the Strategy

• Structure can drive outcomes as much as strategy does. Even with the proper asset allocation and location, the investment vehicle matters. Mutual funds, insurance products, ETFs, and separately managed accounts (SMAs) have different tax characteristics:
• Mutual funds are typically the least tax-efficient pooled vehicle, as portfolio turnover and outflows can trigger taxable distributions for all investors.
• Whole life insurance offers tax-deferred growth and tax-free withdrawals but typically comes with high costs and limited investment flexibility.
• ETFs tend to be more tax-efficient due to their “create/redeem” mechanism, which helps avoid distributing capital gains.
• Non-tax-managed SMAs can be inefficient, often realizing gains without a process to offset them through loss harvesting.
• Tax-managed SMAs offer the most flexibility, enabling client-specific loss harvesting, gain deferral, and in-kind charitable giving. However, turnover will result in capital gains.

Layer 4: Account‑Level Activity – The Day‑to‑Day Tax Levers

Day‑to‑day management is where the differentiated tax alpha is often generated, and many advisors seem to fall short.

At this level, tax management becomes a dynamic, continuous process. It includes:

• Ongoing tax-loss harvesting
• Balancing tax impact and portfolio drift (i.e., tracking error)
• Tax-aware rebalancing
• Strategic gain deferral
• Evaluating trades based on a client’s marginal tax rate
• Donating appreciated securities in-kind

These activities are operationally complex, and without purpose‑built tools or outsourcing, they’re challenging to execute consistently. But the value is real. Studies suggest systematic tax‑loss harvesting can generate up to 190 basis points of after‑tax return improvement annually for high‑net‑worth clients, and between 59 and 134 basis points for mass affluent clients.¹

Estate Planning: Beyond the Scope, But Not the Importance

Proper estate planning is critical for managing a client’s long‑term tax exposure, particularly for high‑net‑worth families. Strategies like gifting, trust structures, and step‑up in basis planning can significantly reduce or defer tax liabilities across generations.

That said, estate planning is a specialized domain with specific legal rules, tools, and planning horizons. While essential, it sits outside the day‑to‑day portfolio decisions covered in this landscape.

We're focusing on the layers of tax management that advisors can most directly influence through investment decisions and portfolio implementation.

Product Selection: Why Structure Can Shape Outcomes in Tax Management

Product selection is often treated as a secondary decision. It shouldn’t be. Choosing between mutual funds, ETFs, and separately managed accounts (SMAs) is central to delivering tax‑aware outcomes.

Mutual Funds: The Legacy Workhorse with Hidden Tax Costs

Mutual funds remain a core building block in many portfolios but come with tax drawbacks, particularly in taxable accounts.

Because mutual funds pool investor assets, any realized gain within the fund must be distributed to all shareholders. Clients can receive a tax bill for gains they never directly benefited from. These distributions often occur without notice, especially near year‑end.

In periods of outflows, fund managers may be forced to sell appreciated positions to meet redemptions, further increasing capital gains distributions.

Whole Life Insurance: Tax Deferral with Constraints

Permanent life insurance, including Whole Life and Variable Universal Life, is occasionally considered a tax‑sheltered investment.

These policies allow for tax‑deferred growth and tax‑free withdrawals up to the cost basis, with the option to borrow beyond that. This may be appealing for clients focused on long‑term deferral.

However, the tradeoffs are significant: high internal costs, limited investment flexibility, complex surrender rules, lack of transparency, and counterparty risk.

ETFs: Tax Efficient But Not Always Flexible

Through their create/redeem mechanism, ETFs address many of the tax issues associated with mutual funds. This feature allows portfolio adjustments to be made in‑kind, minimizing capital gains distributions.

As a result, ETFs are generally tax‑efficient and well‑suited for taxable accounts. Many advisors now rely on them as a default vehicle for core exposures.

However, ETFs have limitations. Because clients do not own the underlying securities directly, loss harvesting is only possible when the ETF trades at a loss to its purchase price. Unless there’s a market‑wide selloff or the ETF is a narrow sector bet, that often leaves few opportunities to harvest losses.

Tax‑loss harvesting active ETFs presents additional complexity. Suitable substitutes may be unavailable and selling the replacement security after the wash sale period can erode the value of the tax‑loss harvesting trade.

Non‑Tax‑Managed SMAs: Missed Opportunities in Disguise

SMAs provide individual ownership of securities, but they can create tax inefficiencies without a tax overlay. Trades may trigger gains without offsetting losses or without consideration of holding period or client‑specific tax rate.

In these cases, SMAs offer the illusion of personalization while missing the key advantage of direct ownership: tax control. Clients may have higher realized gains than they would have incurred in a broad ETF portfolio without a tax‑aware approach.

Tax‑Managed SMAs: The Power of Precision

Tax‑managed SMAs offer a high degree of control. Because clients own individual securities, advisors or overlay managers can:

• Harvest losses
• Defer gains until they become long term
• Donate appreciated securities in-kind

This structure is especially valuable for high‑income clients with large taxable portfolios or concentrated positions. It also helps when working around embedded gains or restricted stock.

However, this approach requires more operational capacity. High‑turnover strategies or portfolios with embedded gains may generate significant capital gains unless managed carefully. Unlike ETFs, SMAs do not benefit from in‑kind rebalancing.

Account‑Level Activity: The Opportunity for Tax Alpha and Why It’s Often Missed

Tax‑aware investing does not end with selecting the proper accounts or product structures. The most consistent and measurable tax value is created through how portfolios are managed day‑to‑day.

This is where tax management moves from strategy to discipline. It is also where the most variation exists across advisor practices.

Several high‑impact actions take place at the account level. They require lot‑level portfolio visibility and should ideally be implemented systematically:

• Tax-Loss Harvesting: Selling securities at a loss to offset realized gains or reduce up to $3,000 of ordinary income annually.
• Tax-Aware Rebalancing: Adjusting allocations using inflows, harvesting losses before realizing gains, and timing trades based on tax brackets.
• Gain Deferral: Waiting to sell to achieve long-term gain treatment or avoid bracket creep.
• Charitable Giving: Donating appreciated securities in-kind to avoid realizing gains while meeting philanthropic goals.
• Marginal Rate-Aware Trading: Evaluating trades based on the client’s current and projected tax brackets, including exposure to Net Investment Income Tax (NIIT), Alternative Minimum Tax (AMT), and phaseouts.

Why It’s Often Missed

Most advisors understand the value of tax management but do not consistently execute it. The issue is not intent. It’s capacity.

Lot‑level oversight across a client base requires scalable automation. Without it, tracking cost basis, monitoring wash sales, adjusting for corporate actions, and optimizing rebalances become unmanageable.

Many advisors only harvest losses once or twice per year. While this may catch some opportunities, it often misses the more consistent value that accrues from year‑round implementation.

Harvesting at Scale: The Case for Automation

Most advisory firms do not have the internal resources to monitor and manage tax decisions across hundreds of accounts. Leading practices typically choose one of two paths:

• Software: Software that assists in harvesting, rebalancing, and tax-aware trade suggestions. These tools can be standalone or integrated with a firm’s systems and operational processes.
• Overlay Managers: Third-party specialists implementing tax overlays while maintaining the advisor’s core investment models.

Each approach has tradeoffs, but both can help meaningfully improve consistency and outcomes.

Technology as a Tax Management Multiplier

Today’s leading tax management solutions offer real‑time, lot‑level portfolio data and automated workflows that embed tax logic directly into portfolio management.

Depending on the solution, these providers offer daily portfolio rebalance checks, lot‑level tax‑loss harvesting, tax‑aware rebalance, client‑specific customizations (e.g., marginal tax rate, security screens, capital gains budgets), charitable giving, household tax optimization, wash sale management, after‑tax reporting, and more.

Overlay Managers vs. Technology Platforms: Which Path to Tax Alpha?

Firms ready to scale their tax management face a core decision: build internal capabilities using technology or outsource execution to an overlay manager.

Each model aims to improve after‑tax outcomes, but they differ in control, operational burden, and resource requirements

Option 1: Technology Platforms

These tools help advisors implement tax‑aware trading in‑house. They integrate with custodians and portfolio systems, offering suggested trades and performance tracking.

Benefits:

• Full control over investment decisions
• Transparent trade review
• No third party is involved in the client relationship

Tradeoffs:

• Requires time and staff to implement and monitor
• Risk of inconsistent execution across accounts
• The advisor bears responsibility for outcomes

When to Choose Tech:

Technology platforms are typically best for firms with centralized investment teams, strong operations, and a preference for hands‑on control. These firms are comfortable investing in tools and staff to maintain in‑house processes.

Option 2: Overlay Managers

Overlay managers act as tax copilots, applying tax‑aware rules to portfolios while maintaining the advisor’s models. They handle tax harvesting, gain deferral, and rebalancing without disrupting the investment strategy.

Benefits:

• Consistent execution across accounts
• No internal trading burden
• Daily harvesting and portfolio checks
• Custom tax budgets and constraints

Tradeoffs:

• Less visibility into day-to-day trade decisions
• Introduces a third party into the client relationship

When to Choose Overlays:

Overlay managers work well for advisors who want to offer tax optimization as a service without managing the details. They are ideal for growth‑focused firms or advisors who prioritize scale.

Still Deciding? Use Both

Some firms adopt a hybrid approach. They use technology for high‑touch clients where control matters and overlays for the broader book where scale is the priority.

Putting It All Together: Designing a Tax‑Aware Practice That Delivers

Tax management is not a single strategy. It’s a system, a layered, integrated set of decisions that compound over time.

It starts with foundational planning, account selection, and asset location. However, real tax alpha is often created through thoughtful product selection and consistent, client‑specific portfolio actions. When these pieces work together, tax management can become a clear and durable source of value. How do leading firms make this work in practice?

1. Make Tax Management a Core Offering

Top firms tend to treat tax management as part of their investment process, not an add‑on or seasonal conversation.

New clients are onboarded with tax considerations in mind. Their accounts, holdings, cost basis, and harvesting preferences are reviewed at the start.

Clients transferring assets receive a tax‑aware transition plan. This helps shift them into the target portfolio without triggering unnecessary gains.

Investment policy statements and proposals include tax assumptions. Investment committees evaluate tax overlay decisions like new managers or models.

If tax management is not built into your process, it’s unlikely to be delivered consistently.

2. Know Your Role and Your Limits

You do not need to become a tax trader or build proprietary software, but you do need to be clear about your internal capacity.

Ask:

• Can my team review tax lots across accounts daily or weekly?
• Can we monitor for wash sales and rebalance under client-specific tax constraints?
• Is supporting this workflow a core competency we want to maintain and invest in?

Understanding where your team adds value and where it needs help is critical for delivering results at scale.

3. Align Product Choices with Tax Objectives

This is one of the easiest and most commonly overlooked places to improve.

If your practice emphasizes tax efficiency, your product lineup should reflect that. In taxable accounts, this typically means:

• Avoiding mutual funds that distribute capital gains
• Favoring ETFs for broad exposure
• Using tax-managed SMAs over unmanaged SMAs

4. Segment Clients by Complexity and Value

Not every client needs the same level of tax management.

Sophisticated firms tend to segment clients based on expected tax exposure and match solutions accordingly.

Three key variables drive tax management value:

1. Percentage of Taxable Assets: Clients with more of their net worth in taxable accounts will require greater focus on the tax impact of portfolio decisions.
2. Marginal Tax Rate: Clients in higher tax brackets often benefit more from every dollar of tax saved.
3. Expected Capital Gains: Harvesting losses only tends to matter if there are gains to offset.

Clients with ongoing capital gains, whether from portfolio turnover, redemptions, or planned asset sales, are often best positioned to benefit from active tax management. Clients with limited gains may not need the same level of complexity.

5. Communicate the Value Clearly

Tax management is often invisible, especially when it’s done well.

Some aspects, like harvested losses, are easy to show. Others, like deferred gains or avoided tax drag, are harder to quantify. Few advisor platforms are equipped to deliver truly personalized, after‑tax performance reporting.

Leading firms often provide a dedicated tax report to make the value visible. This report can help the team assess effectiveness and gives the client tangible proof of the value delivered.

The best reports typically include:

• Losses harvested year-to-date
• Estimated tax savings based on the client’s bracket
• Realized and unrealized gains
• After-tax performance estimates

Tax Management as a Differentiator, Not a Buzzword

Tax management is no longer a niche skill or a once‑a‑year planning tactic; it’s become a defining element of modern advisory practices, especially for firms serving high‑net‑worth clients.

What once required institutional infrastructure is now accessible to advisors of all sizes. Whether through overlay managers or technology platforms, advisors can now offer personalized tax outcomes without adding operational burden or compromising on portfolio design.

Advisors who integrate tax management into their core offering are positioned to:

• Differentiate their practice in a crowded field
• Deliver consistent, measurable value
• Deepen trust with clients who understand the importance of after-tax outcomes

Tax management is more than a service. It’s a signal.

It can show clients that you are thoughtful, disciplined, and committed to managing their financial picture, not just their investments.

The question is no longer whether to offer tax management.

It’s how.

Important Information

Sources:

1. Kevin Khang, Thomas Paradise & Joel Dickson (2021) Tax‑Loss Harvesting: An Individual Investor’s Perspective, Financial Analysts Journal, 77:4, 128‑150.

This material is intended solely for educational purposes and should not be construed as investment advice, a recommendation, or an offer or solicitation to purchase or sell any securities. The opinions expressed are as of the date(s) indicated and are subject to change without notice. Reliance upon the information herein is at the sole discretion of the reader.

Investing involves risk, principal loss is possible. Unlike mutual funds, ETFs may trade at a premium or discount to their net asset value. Shares are bought and sold at market price not net asset value (NAV). Market price returns are based upon the closing composite market price and do not represent the returns you would receive if you traded shares at other times.

This material does not constitute investment advice and should not be viewed as a current or past recommendation or a solicitation of an offer to buy or sell any securities or to adopt any investment strategy. Harbor Capital and its associates do not provide legal or tax advice.

Any tax‑related discussion contained in this material, including any attachments/links, is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding any tax penalties or (ii) promoting, marketing, or recommending to any other party any transaction or matter addressed herein. Please consult your independent legal counsel and/or tax professional regarding any legal or tax issues raised in this material.

ETFs are subject to capital gains tax and taxation of dividend income. However, ETFs are structured in such a manner that taxes are generally minimized for the holder of the ETF. An ETF manager accommodates investment inflows and outflows by creating or redeeming “creation units,” which are baskets of assets. As a result, the investor usually is not exposed to capital gains on any individual security in the underlying portfolio. However, capital gains tax may be incurred by the investor after the ETF is sold.

Shares of ETFs may be bought and sold throughout the day on the exchange through any brokerage account. Shares are not individually redeemable from an ETF, however, shares may be redeemed directly from an ETF by Authorized Participants, in very large creation/redemption units.

This material is not legal, tax or accounting advice. Please consult with a qualified professional for this type of advice.

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