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Top-of-Mind: Tax Efficiency in Taxable Accounts

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At the height of the tax filing season, it’s natural to focus on how much you owe or how much is owed to you in the form of a refund. Significant attention is paid to wages and taxable IRA distributions, of course, but we shouldn’t miss the opportunity to review how taxable non-retirement accounts can impact your tax scenario.

Tax efficiency is integral to a quality investing plan. There are several tax-planning strategies we can pursue within your taxable accounts to minimize tax costs or even capitalize on the opportunities presented by your ownership of taxable non-retirement investment accounts.

Mind Your Annual Income: Be mindful of your total annual income as you proceed. For example, you might experience a low-income year if you’re between jobs or shifting into retirement. Other years, you might receive a big pay raise, sell your business, or otherwise take on extra taxable income. You may be able to speed up your transition by deliberately incurring extra taxable gains in lower-income years and move more cautiously in higher-income ones.

Watch for Tax Thresholds: Try to avoid the “gotchas” that can be triggered when realized taxable gains add to your overall annual income. For example, if the extra income pushes you into a higher tax bracket, your overall marginal tax rate may increase. You may trigger additional add-on taxes, like Net Investment Income Tax (NIIT) or the Alternative Minimum Tax (AMT). Access to other government benefits can also be affected by your reportable income, such as whether or not you are subject to additional IRMAA fees when you qualify for Medicare.

Skip the Short-Term Gains: If you sell a taxable position you’ve held for a year or less, gains are taxed at typically higher short-term rates. It may be worth waiting to sell significant positions until you’ve owned them for more than a year, so the sale qualifies for long-term gain rates.

Harvest Some Losses: Even if your investment plans don’t call for selling particular investments in your taxable accounts, you may still be able to tap them for tax-loss harvesting. By selling any positions in your taxable portfolio at a loss—and promptly reinvesting the proceeds in a similar (but not identical) asset—you can generate realized losses to offset realized taxable gains, without significantly altering your overall portfolio mix. This may free you to realize more taxable gains among the positions you do want to permanently sell.

Be Picky About Lots: Instead of selling an entire fund, ETF, or stock holding, you can sell targeted lots, or share batches, within each. For example, your earliest lot comes from your initial purchase. You also may acquire additional lots through dividend reinvestments, or by buying more shares over time. When it comes time to trade, you might sell particular lots with lower embedded gains, keep those that would incur short-term gains, and/or use specific lots to harvest capital losses, as described.

 

Seizing the Days

As you transition toward your ideal portfolio, life may send you additional opportunities to seize and obstacles to avoid. Following are a few examples.

Take Advantage of Market Declines: When markets decline, stocks go on sale. If your plan calls for selling some positions and buying others, you may be able to take advantage of market downturns to enjoy lower taxable gains as you sell, and better (lower) prices as you buy.

Add New Money to the Mix: Whenever your plan calls for holding more of a particular type of investment, it’s always best accomplished when you can add new money to your portfolio, and invest it accordingly—no taxable strings attached. Have you recently experienced a pay raise, equity compensation event, or inheritance?  Any such “found” money can be ideal for this role.

Withdraw Money Mindfully: Likewise, as you withdraw money from your investment accounts, you can be deliberate about selling positions in which you are overweight, to reduce your exposure to them as planned.

Shift Money from Taxable to Tax-Sheltered: Each year, if you are still working and not yet retired, you are given fresh opportunities to add new money to your tax-sheltered accounts, like 401(k)s and IRAs. You might use these annual opportunities to move assets from your taxable to your tax-sheltered accounts, where trades do not incur taxable gains. This may offer more flexibility for achieving and maintaining your ideal portfolio mix.

Give Your Money Away: If you are charitably inclined or planning to gift assets to loved ones, you may be able to move your portfolio closer to your ideal targets through charitable giving and/or gifting. In short, if you’re planning to give some money away anyway, you might as well be deliberate about which investments you tap for it.

 

If you’re thinking that managing accounts for tax efficiency is complicated, you’re not wrong. Thankfully, qualified tax professionals and seasoned comprehensive planners can help. We encourage you to seek a planner who works to improve your tax outcomes over time.

Your ideal ally will not only provide you with solid numbers to consider; they should also be able to explain tax strategies in a way that makes sense to you. The goal is to gain an empowering sense of control over your investments and the tax outcomes to which they contribute.

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