5 Tax Strategies to Maximize Returns and Minimize Burdens
As you build and manage your wealth, you may find yourself seeking ways to optimize your investment returns while minimizing your tax burden. By understanding how to build a tax-efficient investment strategy, you can make an effort to keep more of your money and put that money to work toward your future.
In this article, we'll explore five tax-efficient investment strategies for high-net-worth individuals that can help you make the most of your portfolio.
1. Find Appropriate Investment Vehicles for Tax Efficiency
One of the foundational principles of a tax-efficient strategy is strategically placing your assets in the different types of accounts. This approach—strategic asset allocation—can help optimize your after-tax returns.
Tax-Deferred Accounts
Tax-deferred accounts, such as Traditional IRAs and 401(k)s, allow you to postpone paying taxes on contributions and investment gains until withdrawal, typically in retirement. These accounts are ideal for holding less tax-efficient assets like bonds and REITs, as the income generated can grow without being subject to immediate taxation.
Taxable Accounts
On the other hand, taxable accounts, like individual or joint brokerage accounts, are subject to annual taxes on interest, dividends, and realized capital gains. However, they may offer more flexibility and potential for tax-efficient growth. These accounts are generally well suited for tax-efficient investments such as growth stocks and ETFs, which can benefit from lower long-term capital gains tax rates.
Tax-Free Accounts
Tax-free accounts like Roth IRAs and Roth 401(k)s offer a unique advantage. While contributions are made with after-tax dollars, both growth and withdrawals are tax-free, provided certain conditions are met. These accounts are well-suited for investments with high growth potential.
For more complex portfolios, alternative investments like private equity or hedge funds can offer unique tax benefits. However, these investments often come with their own tax complexities, so understanding their structure before investing is crucial.
2. Leverage Tax-Efficient Assets
Some investments are inherently more tax-efficient than others, and incorporating them into your portfolio can help reduce your tax burden. Understanding which asset types may offer tax advantages can help you to strategically manage taxable income and optimize your investment returns.
Municipal Bonds
Municipal bonds can be an excellent choice for generating tax-exempt income, especially for those in higher tax brackets. The interest from these bonds is typically exempt from federal taxes and, in some cases, state and local taxes as well.
Exchange-Traded Funds (ETFs)
ETFs are known for their tax efficiency. Unlike mutual funds, which often distribute capital gains to investors each year, ETFs typically don’t trigger taxes until you sell the shares. This allows you to have more control over when you pay taxes on your investment gains.
Tax-Efficient Mutual Funds
Some mutual funds are specifically designed to minimize taxable distributions. These tax-managed funds can be an excellent option for investors concerned about tax liabilities but who still want the benefits of professional management.
3. Manage Capital Gains Efficiently
Capital gains are the profits earned from selling assets, such as stocks or real estate, for more than their purchase price. When it comes to managing capital gains, timing matters. Being strategic about when you sell assets can potentially lower your tax burden.
Delaying Capital Gains
Short-term capital gains are taxed at higher rates, which means that selling assets too quickly may lead to a higher tax bill. By holding onto investments for over a year, you may benefit from lower long-term capital gains tax rates.
Capital Gains Tax Rates for High Incomes
High-net-worth individuals are often subject to higher capital gains tax rates. Consider realizing gains in lower-income years, such as during retirement or when other income sources dip, to potentially benefit from lower tax brackets.
4. Be Strategic About Distributions
Dividends and interest income can create a significant tax burden, especially if distributions are substantial. Strategically planning and timing these distributions can help minimize tax liabilities.
Dividend and Interest Income
For investors with portfolios that generate considerable dividend and interest income, minimizing exposure to high-dividend stocks or interest-heavy investments may help reduce taxes. Consider focusing on qualified dividend strategies, which can offer more favorable tax treatment, or reallocating to investments that generate less taxable income but still align with your financial goals.
Limit Distributions from Certain Investment Types
Income from more complex investments, such as real estate holdings or business interests, can result in significant distributions. Using tax-deferred vehicles, structuring income to spread it over multiple years, or exploring real estate deferral options may help mitigate tax exposure on these distributions.
5. Utilize Tax-Loss Harvesting
Tax-loss harvesting allows you to offset capital gains by selling investments that have declined in value. These losses can be used to reduce your taxable capital gains and even offset up to $3,000 of ordinary income per year, potentially providing a direct reduction to your tax burden.
Reinvest Without Losing Portfolio Balance
After selling an underperforming investment, you can reinvest the proceeds in a similar asset to maintain the desired balance in your portfolio’s asset allocation strategy. This approach allows you to pursue the tax benefit without significantly altering your long-term investment plan. However, be mindful of the IRS’s wash sale rule, which prohibits repurchasing the same or a substantially identical security within 30 days of the sale.
Build a Tax-Efficient Strategy With an Advisor
While the tax strategies touched on in this article can be powerful tools in your investment toolkit, tax laws are complex and constantly evolving. Working with a financial professional means you won’t have to navigate these complexities alone, and you can have a tailored tax-savvy strategy that aligns with your long-term financial objectives.
By taking a proactive approach to tax-efficient investing, you're not just planning for today—you're taking steps toward a more financially confident future. Let's work together to make your money work smarter and go further. Contact the office today to get started building your tax-intelligent investment strategy.
For a comprehensive review of your personal situation, always consult with a tax or legal advisor. Neither Cetera nor any of its representatives may give legal or tax advice.
This material was developed and prepared by a third party for use by your Registered Representative. The opinions expressed and material provided are for general information and should not be considered a solicitation for the purchase or sale of any security. The content is developed from sources believed to be providing accurate information.
