No one likes paying taxes, but tax efficient investing can help reduce your liability. From account type selection to asset class diversification, tax efficient investing has many considerations that could reduce your tax bill and bills.
Tax-efficient strategies can amplify the effects of your savings efforts by decreasing tax liabilities on returns. They’re accessible to nearly everyone and can make an enormous impactful difference to after-tax returns.
Asset Location
Asset location refers to the practice of investing across different accounts to maximize tax efficiency. Asset placement should be part of an overall investment strategy and take into account expected returns (including risk-free rate of return), dividend yields, tax loss harvesting opportunities and minimum distribution requirements.
As a general guideline, placing more tax efficient assets in taxable accounts and less efficient investments into tax deferred and tax-free accounts will reduce annual tax drag while increasing portfolio after-tax return.
Value stocks often produce dividends that trigger capital gains taxes, making IRAs an excellent way to protect these securities and avoid taxes altogether.
As these strategies can become complex, it is advisable to work with an advisor who understands your individual circumstances in order to create an asset allocation plan tailored specifically towards meeting your personal goals, risk tolerance, and investment objectives.
Tax-Loss Harvesting
Under current U.S. tax laws, investors can offset capital gains with capital losses either realized in the same year or carried forward from previous years. Any initial tax savings realized from harvesting these capital losses may be reinvested to compound or used to offset interest expenses over time.
Harvesting can only be performed in taxable investment accounts, unlike retirement accounts where taxes do not accrue on capital gains and losses. Advisors frequently utilize multiple spreadsheets across accounts and portfolios in order to identify opportunities for harvesting, as well as execute trades efficiently.
However, the wash-sale rule can impede an effective loss harvesting strategy by prohibiting purchases of identical or “substantially similar” securities within 60 days prior and post loss harvesting sales. Therefore, developing and implementing holistic multidimensional tax efficient strategies requires expertise; LifeYield’s integrated tax platform can assist your Morgan Stanley Financial Advisor in optimizing these strategies for their clients.
Strategic Withdrawals
Tax efficiency depends heavily on how funds are withdrawn from accounts. For maximum tax efficiency, it is wise to withdraw funds first from taxable accounts (such as brokerage and bank savings accounts) before withdrawing them from tax-deferred and tax-free accounts in order to preserve more of your return over time. This strategy may require extensive knowledge of your personal tax situation, financial goals and account structures as well as consulting a professional advisor for assistance – contact a financial or tax advisor if any clarification or guidance is necessary.
Tax-efficient investing is an integral component of a comprehensive investment portfolio that can help mitigate the impact of taxes on overall returns, accelerate wealth accumulation and maximize after-tax return potential. By taking advantage of unique tax benefits like asset location and tax loss harvesting strategies, tax-efficient investing can increase after-tax return potential and help increase wealth accumulation over time.
Asset Allocation
As part of their investment planning strategy, investors should also carefully consider how taxes may impede their returns. By minimizing tax impacts on their returns, individuals can keep more of their investments intact.
Tax-efficient investing strategies involve choosing accounts that best suit certain assets and taking full advantage of any available tax breaks. For instance, taxable brokerage accounts may be best for stocks and equity mutual funds which lose less to taxes than bonds; while accounts that provide tax benefits such as IRAs and 401(k)s could provide better opportunities.
Index and tax-managed stock funds often boast lower turnover rates, leading to reduced taxable capital gains distributions compared with actively managed mutual funds. Municipal bonds may also benefit from tax exempt status in many cases – often both federally as well as locally.
