The Keys To Tax Efficient Investing
Taxes play a significant role in determining how much of your investment income and gains you keep.
The principal factors in determining the amount you earn on your investments are asset allocation tailored to your personal profile and investment selection. The principal factors in determining how much of those earnings you keep are fees, expenses, and taxes. In fact, taxes can take more than 50% of your investment earnings after fees and expenses in some cases.
There are three basic types of investment accounts. Taxable accounts, such as brokerage accounts. Tax-deferred accounts such as 401(k) and traditional IRA accounts. Tax-exempt accounts, such as Roth IRA accounts.
To keep taxes at a minimum, you need to: (1) consider maximizing contributions to tax-deferred and tax-exempt accounts: (2) position your investments so that you have the correct type of investment in the right type of account; and (3) monitor your taxable account(s) throughout the year to implement tax strategies as appropriate.
There are three major asset classes. Equities, such as stocks, stock mutual funds, and stock ETFs. Fixed income, such as corporate bonds, municipal bonds, and bank CDs. Other, such as real estate and commodities. Within each class there are individual investments that create fully taxable income, partially taxable income and tax-exempt income.
Listed below are some basic strategies that will help you achieve your goal of minimizing taxes on your investment income.
- To the extent that it aligns with your overall investment plan for asset allocation and investment selection, place investments that generate fully taxable or partially taxable income in your tax-deferred or tax-exempt accounts. These would include investments that will provide fully taxable interest, non-qualified dividends, and short-term capital gains. For example, corporate bonds that produce fully taxable interest; dividends from non-qualified foreign corporations and certain preferred stocks; and stocks and other capital assets held for one year or less.
- Place investments that will generate tax-exempt or partially taxable income in your taxable accounts. An example of these types of investments would be municipal bonds that produce tax-exempt income, growth stocks that produce long-term capital gains, stocks that produce qualified dividends, and REITS that provide the 20% tax deduction for qualified business income.
- Structure withdrawals from your accounts to achieve the best result each year. Generally, this would be drawing from your taxable accounts first since there would be little or no current-year taxable income. However, you need to coordinate this with your financial adviser and CPA to ensure the best result.
- Monitor your taxable accounts throughout the year to hold investments long enough to qualify for long-term capital gains, to take advantage of tax loss harvesting, to screen for investments that have lost their favorable tax attributes and search for equivalent investments that have more tax efficient attributes.
Winthrop Partners is a fee-only fiduciary that provides wealth planning and investment management services. Please contact us at winthroppartners.com or 267-454-7551. Our team can help you make successful retirement, financial planning, estate planning, and investment decisions.
The information provided herein is for educational purposes only and should not be considered investment, tax, accounting, or legal advice. Winthrop Partners does not provide tax advice or legal advice. The information contained herein may also be subject to change. Winthrop Partners has made every attempt to ensure the accuracy and reliability of the information provided, but it cannot be guaranteed. Before taking any action, you should first consult with a tax or legal professional
Thomas Bunting is a Financial Advisor at Winthrop Partners. He has more than 50 years of experience in accounting, financial planning, and tax planning. Prior to joining Winthrop Partners, Tom held the roles of partner, managing partner, and senior partner with a mid-sized CPA firm that provided a full range of accounting, tax and financial planning services.
Tom is a member of the American Institute of Certified Public Accountants, the Personal Financial Planning and tax sections of the American Institute of Certified Accountants, and the Pennsylvania Institute of Certified Public Accountants. He was also a former member of the AICPA governing council and a past president of the PICPA. He earned his BS in Accounting from Temple University.
