Author: Brent Lemieux CFA® CPA

I’d like to state the obvious: taxes are a bummer.

They aren’t fun to pay.  They aren’t very interesting to learn about.  It generally feels better if we just don’t think about them.  However, if we ignore taxes when making investment decisions, there’s a strong likelihood we’ll end up with significantly less money in retirement.

We have a tendency to focus on the performance of our investments before taxes.  This approach doesn’t make much sense.  After all, it’s the after tax value that we get to spend on things we enjoy, leave for our
kids, or donate to charity.

Of course, we don’t want to limit our focus to taxes and nothing else. Tax is only one of many considerations that investors should be mindful of.  It doesn’t make any sense to avoid an investment just because it generates tax.  By combining smart investment principles and tax efficient strategies, however, we can setup a sensible investment plan that is also tax efficient.  With that in mind, I’d like to share several strategies that will allow you to defer and reduce  your tax bill without having to change your overall investment strategy.

Tax loss harvesting

Tax loss harvesting is a technique that allows you to lower your current tax bill by selling assets that are trading below the value you purchased them for and replacing them with a comparable asset.  You can then invest the amount you saved on tax allowing the savings to compound over time.  Make sure you only do this in your taxable accounts.  If you sell an asset at a loss, you must wait thirty days to repurchase the same asset, or your loss deduction will be denied due to the “wash sale” rules.

Tax location of assets (a.k.a. asset location)

Tax location is a strategy that allows you to reduce taxes over time by placing certain assets in the investment account  (think IRA, 401(k), Roth IRA, and taxable brokerage accounts) that is most efficient for that asset class.  Example:  corporate bond interest is taxed as ordinary income whereas qualified dividends and long term capital gains from  equity sales receive favorable treatment.  If you are in the 28% tax bracket, you will pay the IRS 28% of taxable interest income you receive unless you place those bonds in an IRA.  You can then put your equities in your taxable account to take advantage of the favorable treatment.

Investment security type selection

Do you use ETFs or Mutual Funds?  They both have their pros and cons, but ETFs can be a much better option for taxable accounts if used correctly.  ETFs allow you better control of when you will take taxable gains, whereas Mutual Funds dictate when they will payout capital gain distributions, which may leave you with an unexpected tax bill.

Investment vehicle type selection

Should you setup a regular IRA or a Roth IRA to save for retirement?  Or maybe you already have an IRA.  Should you convert it to a Roth?  If so, when?  The answer to these questions is complicated and depends a great deal on your personal situation.

Over the coming weeks, we will be releasing articles that cover these topics in greater detail, so stay tuned!

If you want to decrease the tax burden from your portfolio, but reading about taxes makes you want to claw your eyes out, contact a Windward Wealth Manager today.

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