Tax-efficient investing isn’t just a buzzword — it’s a foundational strategy and area of expertise that many people don’t fully apply to their investments and financial plan. The result? Enhancing after-tax returns, reducing your tax burden, and accelerating your journey toward your financial goals. If the term “tax-efficient investing” is new to you, working with advisors who are well-trained and experienced in tax planning is essential. They’ll help ensure you’re building your wealth efficiently and keep it working for you, your family, and those you care about.
An effective tax-efficient investment plan starts with understanding the various types of accounts available — sometimes referred to as “financial buckets” — and how to effectively utilize each one in your asset location strategies.
- Tax-deferred accounts (traditional investment retirement account (IRA), 401(k), 403(b)): These accounts let you defer taxes on the investment’s income and gains until you withdraw the funds. They’re an ideal place to hold your income-generating assets because they allow you to shelter earnings from immediate taxation while optimizing long-term growth.
- Roth accounts (Roth IRA, Roth 401(k)): Roth accounts — initially funded with post- tax dollars — offer the power of tax-free growth and withdrawals. By prioritizing high-growth assets in a Roth account, you can maximize the potential of compounding without a future tax bill, making this type of account an attractive cornerstone of a forward-looking strategy.
- Taxable brokerage accounts: A taxable account is just as it sounds — interest, dividends, and capital gains from asset sales are recognized each year on your tax return. Because investors are paying tax on the income and gains earned in these types of accounts, it’s critical to understand the tax characteristics of different types of investment vehicles (ETFs, mutual funds, separately managed accounts, etc.), and the assets owned within said vehicles.
Ongoing monitoring and tactical adjustments
Tax-efficient investing is not a simple “set it and forget it” endeavor. Staying proactive throughout the year is key. The following strategies can help reduce your tax burden and maximize your portfolio.
- Strategic rebalancing: Rather than simply adjusting your investments for risk and return at the start of each calendar year or calendar quarter-end, reviewing your portfolio frequently and strategically throughout the year can minimize taxable events and add value to your bottom-line returns. Your financial advisor can work with you when markets are volatile to maximize opportunities as they occur.
- Tax loss harvesting: By selling investments that have declined in value, you can offset capital gains and reduce taxable income, all while staying fully invested and participating in market recoveries. That said, it’s important to weigh many factors when implementing this type of strategy to not let taxes overrule sound investment decision-making.
- Distribution skips: This year-end planning technique involves monitoring your fund dividend and capital gain distribution schedules and potentially skipping a distribution — or waiting to buy into a fund until after a distribution is made — improving your overall tax position. Your financial advisors can help you track the schedules and propose strategies that may benefit you.
- Capital gain management: Effectively managing capital gains means keeping a close eye on investment holding periods and reviewing individual tax lots before making trades. By working alongside your advisor throughout the year, you may uncover opportunities to improve your tax situation prior to year-end, making the most of techniques like loss carryforward.
The art of withdrawal strategies
Building your wealth in a tax-efficient manner is important, but how you spend and distribute it matters too. Smart withdrawal strategies — like what types of accounts to tap into first in retirement — can keep your tax bill lower in retirement. Proactive management throughout the year can help optimize charitable giving strategies such as bunching of deductions and utilization of donor-advised funds or qualified charitable distributions. Your advisors can also help strategize required minimum distributions and other moves like Roth conversions while also keeping an eye on your Medicare income-related monthly adjustment amount (IRMAA). Managed holistically, well-coordinated withdrawal strategies can make a significant difference in your financial plan’s success.
Why work with a fiduciary advisor?
Implementing a tax-efficient portfolio has its complexities, but the good news is you don’t have to navigate it alone. With the guidance of a fiduciary advisor who evaluates your interests, you have an extra set of eyes to help you build a strong portfolio, minimize your tax burden, maximize returns, and accelerate your journey towards your financial goals. Why should you choose an independent and objective fiduciary advisor? They work for you — they’re legally and ethically bound to evaluate your interests, focusing on your net after-tax returns. In practical terms, this translates into helping you choose from a wide universe of investments, design a personalized strategy that suits your risk/return profile, and stay you on track as tax laws and your life evolve.
Start early, reap the rewards
The earlier you begin implementing these strategies, the greater your long-term benefit. By keeping more of what you earn and compounding your investments in a tax-efficient manner, you’re boosting the growth potential of your investments and effectively paving the way to your financial goals.
