Four Tax Efficient Investment Strategies

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Keep More Money in Your Pocket

On average, Americans pay $10,453 in personal taxes each year which equals 14% of the average household income ($74,664).  If you live in California or New York, then you pay much more, on average.  Tax planning is an effective way to keep more money in your pocket, especially in high tax states.

It’s normal to feel anxious and think financial planning is complicated and time-consuming, but it may be easier than you think to optimize your assets, decrease financial stress, and increase your cash flow.  While planning, tracking, and monitoring resources are key components, this blog will focus on tax efficient strategies for investment portfolios.

Tax Efficient Investing Strategies

Investors may get caught up in the day-to-day trading opportunities and forget to step back to take advantage of tax strategies.  Here are four tactics that may synergistically build wealth and minimize your tax liability.

1) Tax-loss harvesting

When corrections and market volatility are prevalent, investors may intentionally sell securities at a loss to counteract tax liability. During December 2018, financial firms were working with clients to determine how their current losses would help reduce overall tax implications. This is done by assessing the known tax situation against the harvesting opportunity.  Advisors sell a security at a loss, wait 31 days (to avoid a wash sale), then repurchases the security if he or she believes it’s a strong, long-term investment advantage. The taxpayer then receives the benefit of taking the loss against capital gains.  This offset typically reduces the total tax due. It sounds simple enough, but a word of caution is prudent.  It is easy to misjudge or miscalculate your true harvesting needs, therefore, talk with a trusted professional before engaging in this strategy. It’s as simple as making a phone call to your advisor.

Related Reads: Year-End Tax Planning

2) Managing capital gains

Capital gains rates have a significant tax benefit for many Americans.  Depending on income and marital status, taxpayers will pay 0%-20% in long-term capital gains tax, instead of ordinary income tax rates. Some taxpayers enjoy up to an additional $70,000 in capital gains with virtually no tax consequence. Your tax planner should be able to tell you how much you can take without increasing your taxes due. 

Investment vehicle selections also impact capital gains tax.  Mutual funds can give off capital gains to their owners at any time in the year.  The capital gain occurs when the mutual fund sells the securities within the fund, not when you decide to sell the fund.  By selecting low-cost, Exchange-Traded Funds (ETFs), you can stay in control of the timing for realizing your gains.  

There are a few more strategies to think about when considering capital gains treatment.

1.       Qualified dividend offerings over non-qualified dividends may also provide a tax advantage.

2.       Keep good records. Before you sell a security, it is prudent to review the securities’ original purchase date before you sell.  If you sell the stock within 365 days of purchase, you will be taxed at ordinary income rates, but if you wait until at least day 366, then you qualify for the long-term capital gain rate.

Related Reads: 3 Mistakes Investors Make During Volatile Markets

Related Reads: Top 4 Common Retirement Mistakes

3) Distributin strategiesNot only should an advisor or investor consider how investment decisions impact wealth, but there are also tax benefits for planning how you will distribute your assets over time.  It is wise to establish and build a taxable account, a tax-deferred account, and a Roth IRA.  Trust/Individual accounts are taxable accounts and incur capital gains tax when an asset is sold. However, the amount you distribute from the account is free from ordinary income tax. Your retirement accounts, on the other hand, do not pay a capital gains tax.  Instead, the distributed amount is taxed at ordinary income rates. With a Roth IRA account, the investor contributes with after-tax dollars (no tax benefit), but when a qualified distribution is made, the amount distributed later is tax-free.  There are no taxes on gains for the income being distributed.  A tax planner can help you assess the size, type, and goal for each account type, and provide you with a tax-efficient approach when income is needed during retirement.

4) Transition management

When an investor chooses to hire an investment manager, there is typically a need to transition the account positions into a new strategy.  Many firms require the investor to sell 100% of the assets and move the cash into the new investment model, regardless of the potential tax problem this decision may create. A tax-aware advisor, however, will analyze the current portfolio, determine the selling consequences, and look for alternatives to create a well-positioned portfolio. Good advisors can actively manage and transition a tax-sensitive account by partnering with their client to reflect a comprehensive approach to building wealth.

Additional Tax Planning Strategies

Gaining a clear understanding of how your money moves across accounts and investments may reveal opportunities that otherwise would be missed. For example, married couples who are both working may be able to maximize their retirement savings across different account types (401K, IRAs, Roths, etc.) without breaking the rules or incurring penalties.  Without a plan, you may end up with excess contribution costs, or you may be paying taxes on assets that could have been tax-deferred.

Career Stage Wealth Accumulators

Employer-Sponsored Programs can be a great tool for tax relief. You may have access to Defined-Contribution plans, Defined-Benefit plans, IRAs, Roth IRAs, and SEP IRAs.  There are also Simple IRA still available in some companies. Additionally, your W-2 tax withholding, additional medical and life insurance withholdings, and wage expectations can be analyzed so that you have access to your maximum earnings while securely understanding your potential tax liabilities during tax season.

The planning process is best completed through a collaborative effort between you and your tax planner. Coming in ready to brainstorm, share your thoughts, ask questions, engage in some debate and discussion about alternatives.  If you plan to provide a few sheets of data to your planner and then have them do all of the work in isolation of your input, then it is likely you will end up with less than the best tax planning results.  Find someone whom you connect with and feel comfortable sharing this information so that the human element is considered as well as the numbers.

Lighthouse Financial is a fee-only firm that provides investment management, financial planning, and tax preparation services under one roof. Contact us today to begin your 2019 tax planning. We are located in North Orange County serving clients in Brea, CA for 27 years.

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*The foregoing content reflects the author's personal opinions which may not coincide with the opinions of the firm, and are subject to change at any time without notice. Content provided herein is for informational purposes only and should not be used or construed as investment advice or a recommendation regarding the purchase or sale of any security. There is no guarantee that these statements, opinions, or forecasts provided herein will prove to be correct. Past performance is not a guarantee of future results. Indices are not available for direct investment. Any investor who attempts to mimic the performance of an index would incur fees and expenses which would reduce returns. All investing involves risk. Asset allocation and diversification does not ensure a profit or protect against a loss. Finally, please understand that–as with other social media–if you leave a comment, it will be made public.