Our advisors tout the merits of tax-efficient planning strategies every day. At a very high level, moving money into certain types of accounts at the right time — in a way that lines up with clients’ goals — can save them substantial amounts of tax dollars. The goal is to take a broad enough view of their total financial picture that we can help them move around their money in a way that maximizes impact and minimizes taxes. After all, taxes are a cost and the more you’re paying the IRS, the less of your money you have available to become and remain financially self-reliant. That's why tax considerations are such a crucial part of any comprehensive financial plan, or Goals Analysis as we call it at GWS.
Given the transformative power of tax-efficient planning, I thought it was worth taking time to delve more deeply into just how valuable a solid tax strategy can be. The strategies below, as well as our tax planning software that generates historical tax reports, observations and tax projection scenarios, are just some of the tools we use to help guide our clients in making tax-efficient decisions. As you work through end-of-year planning with your advisor, feel free to discuss any of these ideas with your advisor to learn if they might be appropriate for your personal situation.
1. Tax Loss Harvesting We keep an eye on your taxable investments that have lost value, replace them with similar investments, and use the investment sold at a loss to offset any gains from the new investment. By offsetting gains, we can help keep your overall tax bill lower. Please note that this strategy only applies to taxable accounts (versus non-taxable accounts such as 401(k)s and IRAs).
2. Tax Bracket Management If you’re teetering on the edge of a tax bracket, we’ll help you determine which bracket is best for you to fall into. Then, our approach is to determine how we can fill that bracket all the way up to the top without going over. For instance, a recent client had $30,000 of room left in a low-income tax bracket, and we suggested taking a extra distribution from a qualified plan that year to maximize the tax bracket. Over time, we can help clients reduce taxes in future high-income years by realizing more income in their low-income years. This type of strategy is particularly relevant with today’s historically low tax brackets and high-income ranges.
3. Roth IRA Conversions (or Contributions) A Roth IRA is a special retirement account where you pay taxes on money going into your account and then all future growth is tax-free. Roth IRAs are best when you think your marginal taxes will be higher than they are right now. If you are in a lower tax bracket and have Traditional IRA assets, a Roth IRA conversion strategy could also utilize the tax bracket management approach mentioned above. With a Roth IRA conversion, we could take money from a Traditional IRA and transfer it to a Roth IRA for that year. Income tax will still need to be paid on the amount converted, however, this lets us take advantage of a smaller income bracket. in which any growth will be tax-free.
4. Back Door Roth IRA Contributions If you're not eligible to make a Roth IRA contribution because you’ve phased out over the income thresholds, you may be able to do a non-deductible IRA contribution that converts into Roth IRA. This strategy has other considerations to keep in mind if you have Traditional IRA assets outside of your 401(k), therefore you will want to work with your Lead or Service Advisor to determine if you are eligible for this strategy.
5. Qualified Longevity Annuity Contract (QLAC) A QLAC is a deferred fixed annuity contract that can help decrease required minimum distributions (RMDs) and the associated taxes. In other words, it gives you the chance to delay a portion of your required minimum distributions from age 72 up to age 85. So, if you do not need the money now, it might be better to delay the distributions to save taxes.
6. Annuities Annuities are another way to utilize non-qualified tax deferral. You don’t have to pay taxes if the annuity is non-qualified, and you also don’t have to pay capital gains — giving you a guaranteed income stream. Do keep in mind that taxes will have to be paid at the current income tax rate at the time of distribution. *See Disclosures Below
7. Donor Advised Fund A donor-advised fund is a charitable investment account, for the sole purpose of supporting charitable organizations you care about. When you contribute cash, securities or other assets to a donor-advised fund, you are eligible to take an immediate tax deduction. If you contribute securities, you get a double tax benefit as the capital gain on the holding is not taxable when you sell the holding. Then those funds can be invested for tax-free growth and you can recommend grants (over any time period) to almost any IRS-qualified public charity.
What About Investing? Finally, making tax-efficient decisions doesn’t just apply to financial planning. It can also be a critical piece of your investment strategy. For instance, we have a specific “Tax-Wise” strategy designed especially for clients who consider low taxes as their number one priority. Maybe they’re high earners who need to keep taxes down, or maybe they simply hate paying taxes! Our Tax-Wise strategy uses a proprietary ranking model to help us avoid high turnover and short-term gains (which could have meant turning over half of someone’s earnings to Uncle Sam). In the past, we
used mutual funds for this strategy. However, we’ve since transitioned to primarily using ETFs — which reduce or avoid capital gains distributions entirely. Using this approach, we can help hold positions until they become long-term gains, with the goal of optimizing our after-tax results. *See Disclosures Below Everyone can count on taxes, but by being smart about the way you manage your tax strategy, you might be able to keep more money in your pocket than you think. Be sure to talk with your advisor if you have any further questions about how to leverage these strategies for your own financial plan (Goals Analysis) and investment portfolio.
--
Disclosures
* This material was created for educational and informational purposes only and is not intended as tax, legal, or investment advice. You should consult with your attorney, tax, or financial advisor for guidance on your specific situation. All investing involves risk including loss of principal. No strategy assures success or protects against loss.
* Fixed and Variable annuities are suitable for long-term investing, such as retirement investing. Gains from tax-deferred investments are taxable as ordinary income upon withdrawal. Guarantees are based on the claims paying ability of the issuing company. Withdrawals made prior to age 59 1⁄2 are subject to a 10% IRS penalty tax and surrender charges may apply. Variable annuities are subject to market risk and may lose value.
Mutual funds and ETFs are sold by prospectus. Investors should consider the investment objectives, risks, charges and expenses of the investment company carefully before investing. The prospectus and, if available, the summary prospectus contains this and other important information. You can obtain a prospectus and summary prospectus from your financial representative. Read carefully before investing.