Investment vehicles and accounts with tax-efficient strategies are an integral component of wealth management. While certain investments may carry risks of IRS penalties for tax evasion, thorough analysis with the assistance of a certified accountant or financial investment advisor can reduce tax obligations while meeting investment goals.
Tax-Advantaged Accounts
Selecting investments and accounts with tax-efficient features are essential to increasing after-tax returns. Investments that lose significant returns to taxes should be held within tax-advantaged accounts such as an IRA, 401(k), 529 savings plans, or health care expenses savings accounts (HSAs).
Tax-exempt investments such as municipal bonds can make an effective contribution to a tax-efficient portfolio. They’re usually exempt from federal and, sometimes, state income taxes and may provide attractive tax breaks for investors in higher tax brackets.
Reducing taxes through strategic rebalancing and careful asset class selection is also a proven approach to optimizing returns after taxes have been paid. A professional can help you allocate assets between tax-advantaged accounts and taxable ones in order to increase after-tax returns.
Tax-Deferred Vehicles
Tax-deferred investments such as IRAs, Roth IRAs and 529 plans don’t subject their earnings to taxes every year; rather, their growth occurs tax-free until withdrawal occurs.
Tax-efficient investing requires taking an integrated approach that involves using tax-deferred accounts and tax-favorable investments as leverage points and employing specific strategies such as rebalancing annually, harvesting losses when possible, and charitable giving. Furthermore, one must also carefully consider IRS rules and regulations while employing best practices for managing taxes.
Many advisors are turning to private placement variable annuities as a tool to reduce federal taxes on alternative investments and other strategies that generate taxable income, helping wealthy investors increase after-tax returns and compounding power.
Strategic Asset Location
Even for portfolios that are already well-diversified, incorporating tax management strategies with careful thought can substantially boost returns. According to Michael Kitces’ research in financial field, benefits could average out at about 0.25% annually on average.
Asset location refers to selecting assets for placement into accounts that will maximize after-tax return, following an investor’s risk tolerance and desired asset allocation decisions. An example may include allocating 60% stocks and 40% bonds as desired – yet that only tells part of the story.
A key part of asset allocation involves selecting which asset classes should go in taxable, tax deferred or tax-free accounts. Value stocks tend to distribute dividends that are less taxable than growth stocks, so they make sense as investments for Roth IRAs or health savings accounts where holdings in these accounts could have potential tax advantages. Research shows that more wealth placed into these accounts increases potential benefits.
Tax-Efficient Investments
Avoiding taxes altogether may not be possible, but managing their impact on your portfolio should be one of your main goals for investing. Finding an account type and asset location suitable to this goal is essential in doing so.
Investments with built-in tax efficiencies, like index mutual funds and ETFs (exchange-traded funds), can help investors reduce the amount of returns lost due to taxes. Tax-managed funds that settle their transactions in such a way as not to trigger capital gains are another useful strategy, while municipal bonds offer income exempt from federal (and often state) taxes are another great choice for reducing one’s tax bill.
If you want to know more about how to expand your wealth without incurring an excessive tax burden, consulting a financial or investment professional could be invaluable. They will assess your current situation and advise if any adjustments need to be made or suggest investments with particular tax benefits – for instance private placement variable annuities could provide effective after-tax returns on alternative strategies that generate taxable income.