Switching financial advisors can come with tax implications that investors should be aware of. For one, the transfer of assets between accounts may trigger taxable events, particularly if investments are sold to facilitate the transfer. Additionally, fees associated with the switch—such as exit fees or early withdrawal penalties—could potentially have tax consequences. Investors should also consider how their new advisor’s approach to investment management might impact their overall tax strategy.
Do You Owe Taxes When You Switch Advisors?
Simply changing from one financial advisor to another does not, on its own, result in any tax liabilities.
The process of transferring your accounts or assets to a new advisor can typically be done without creating a taxable event, as long as no assets are sold in the process.
Most financial institutions offer what’s called an “in-kind transfer,” where your investments are moved directly from one firm to another without being sold or converted into cash. This type of transfer allows you to avoid taxable events.
That said, taxes may arise depending on how the transition is handled—though the act of switching advisors itself doesn’t inherently create a tax obligation. Rather, it’s the handling of your assets during the switch that could make a difference in your tax situation.
When Changing Advisors Triggers a Tax Bill
As mentioned, changing financial advisors can trigger a tax bill depending on how your assets are managed during the transition. One of the primary ways this happens is if your investments are sold as part of the switch.
For example, if your previous advisor held investments that your new advisor chooses to sell, those sales can create taxable events. If the investments have appreciated in value, you may face capital gains taxes. Long-term capital gains (for assets held more than a year) are taxed at a lower rate, while short-term capital gains (for assets held less than a year) are taxed as ordinary income, which can be a higher rate.
Another tax scenario occurs if you have retirement accounts, like a 401(k) or an IRA. While transferring these accounts between advisors usually doesn’t incur taxes, withdrawing funds as part of the switch can lead to income taxes, and potentially early withdrawal penalties if you are under the age of 59 ½.
Other Fees You May Incur for Switching Advisors
Beyond taxes, a variety of fees may arise when you switch advisors depending on your current investments and the terms of your accounts. While these fees can vary, understanding the potential costs upfront can help you avoid unexpected expenses during the transition.
Common fees include account closure fees, which financial institutions may charge for transferring your accounts to another firm. Additionally, some investments, like mutual funds, may have redemption fees if sold within a certain time frame.
Further, if your new advisor recommends selling certain holdings, you could also incur trading commissions or brokerage fees. There also may be transfer fees for moving assets between firms, especially if a direct or in-kind transfer isn’t possible.
How to Avoid Taxes When Switching Advisors
There are strategies to minimize or avoid tax liabilities when switching advisors. Below are four common tips you can take to help reduce the tax impact when making a switch:
-
Use an in-kind transfer. Whenever possible, request an in-kind transfer of your assets, which moves your investments directly to your new advisor without selling them. This helps avoid triggering capital gains taxes.
-
Time your asset sales carefully. If asset sales are necessary, consider selling investments in a tax year when you expect lower income, which may reduce your capital gains tax rate.
-
Offset gains with losses. If you have appreciated assets to sell, consider selling investments that have lost value to offset your gains and reduce your tax liability.
-
Take advantage of tax-advantaged accounts. Moving assets between tax-advantaged accounts like IRAs or 401(k)s can usually be done without incurring taxes, provided you follow IRS rules for rollovers or direct transfers.
Examining Tax Outcomes
Let’s look at two hypothetical investors, John and Michelle, who both decide to switch financial advisors but experience different tax outcomes based on how their transitions are handled.
Scenario #1: An investor has a taxable brokerage account with several appreciated stocks that they held for less than a year. Their new advisor recommends restructuring their portfolio by selling some of these stocks to align with a more balanced strategy.
The tax outcome: As a result, the investor triggers short-term capital gains taxes, which are taxed at their ordinary income rate. Since the investor is in a higher tax bracket, their tax bill is substantial. Additionally, because they sold the stocks before they became long-term holdings, they missed out on the lower tax rate applied to long-term capital gains.
Scenario #2: Another investor, on the other hand, also has a taxable account but chooses to move their investments via an in-kind transfer, meaning that their assets are transferred directly to their new advisor without selling them. The investor’s new advisor decides to keep their portfolio intact initially and gradually adjusts it over time, taking advantage of tax-loss harvesting by selling underperforming assets to offset gains.
The tax outcome: The second investor avoids immediate taxable events during the transfer and limits their future tax liabilities by managing capital gains more strategically.
Bottom Line
Switching financial advisors can be a smooth process, but it’s important to know about the potential tax implications that may arise, depending on how your assets are handled. While switching advisors doesn’t automatically result in taxes, certain actions—like selling investments or making early withdrawals—can trigger tax liabilities. Careful planning and working closely with your new advisor could help you keep your financial goals on track during the transition.
Tips for Finding a Financial Advisor
-
Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
-
Be sure to ask candidates the right questions, including whether they are a fiduciary or not. This means they are legally bound to put your interests before theirs or their firm’s.
Photo credits: ©iStock.com/Charday Penn, ©iStock.com/filadendron, ©iStock.com/VioletaStoimenova
The post What Are the Tax Implications of Switching Financial Advisors? appeared first on SmartReads by SmartAsset.
