Leading with Tax-Wise Investing
It’s one thing to have the tools just described. It’s another to make the best use of them.
We view effective tax planning as a way to reduce your lifetime tax bill—or beyond if you’re preparing for a tax-efficient wealth transfer to your heirs.
In short, tax planning is an ongoing campaign staged on multiple fronts. One of the most powerful ways to ward off excess taxes is to be tax-wise about your investing. And yet, few investors take full advantage of the many opportunities available at every level. These levels include how you manage your investment accounts, select individual holdings, and buy and sell those holdings along the way.
As you manage your investment accounts …
Are you doing all you can to build, manage, and spend down your taxable and tax-sheltered accounts for maximum lifetime tax efficiency?
- Building: Are you maxing out your contributions to appropriate tax-sheltered accounts? The more money you hold in various tax-sheltered structures, the more flexibility you’ll have to delete or at least defer taxes otherwise inherent in building capital wealth.
- Managing: Are you deliberate about your asset location, dividing your various assets among your taxable vs. tax-sheltered accounts for overall tax efficiency? Ideally, you use your tax-sheltered accounts to hold your least tax-efficient holdings while locating your most tax-efficient holdings in your taxable accounts.
- Spending: When the time comes to spend your wealth, have you planned for how to tap your taxable, tax-deferred, and tax-free accounts? There is no universal answer to this critical query. Cash-flow planning calls for deep familiarity with the particular accounts and assets you’ve got, the particular rules involved in deploying each, and your particular spending goals. All that while keeping a close eye on any changes that may alter your plans.
As you select individual holdings …
Are you being deliberate about selecting tax-efficient vehicles? Even when different funds share identical investment objectives, some may be considerably better than others at managing their underlying holdings. Seek out fund managers with solid tax-management practices, including:
- Patient Investing: Many fund managers try to “beat” the market by actively picking individual stocks or timing their market exposures. We suggest using managers who instead patiently participate in their target market’s long-term expected growth. A patient investment strategy not only makes overall sense, but it’s also typically more tax-efficient as it involves less, potentially taxable action.
- Tax-Managed Investing: Some fund managers offer funds that are deliberately tilted toward tax-friendly trading techniques for your taxable accounts. Such methods include avoiding short-term (more costly) capital gains and aggressively realizing capital losses to offset gains.
As you buy and sell holdings …
Like the fund managers you choose, are you also being patient and deliberate about your trading? Do you avoid excessive trading and short-term capital gains (currently taxed at higher rates)? Are you guided by a personalized investment plan? Bottom line, the fewer trades required to stick to your investment plan, the better off you’re likely to be when taxes come due.
Harvesting Capital Gains and Losses
An investment plan also facilitates your or your advisor’s ability to identify and make the best use of tax-loss and tax-gain harvesting opportunities when appropriate.
Tax-loss harvesting typically involves:
- Selling all or part of a position in your portfolio when it is worth less than you paid for it.
- Reinvesting the proceeds in a similar (not “substantially identical”) position.
- Optionally returning the proceeds to the original position after at least 31 days have passed (to avoid the IRS “wash-sale rule”).
Without significantly altering your portfolio mix, you can then use any realized capital losses to offset current or future capital gains.
It’s worth noting, tax-loss harvesting typically lowers a harvested holding’s cost basis. So contrary to popular belief, you’re usually postponing rather than eliminating taxable gains. Why bother? More time gives you more control over when, how, or even if you’ll realize the gains. For example, you could wait until tax rates are more favorable or reduce embedded gains over time through gifting, charitable giving, or estate planning tactics.
Tax-gain harvesting involves selling appreciated holdings to generate taxable income deliberately. Why would you do that? Remember, your goal is to minimize lifetime taxes paid. So, especially once you’re tapping your portfolio in retirement, you may intentionally generate taxable income in years when your tax rates are more favorable. You’re sacrificing a tax return battle or two, hoping to win the tax-planning “war.”
Past performance does not guarantee future results. All investments include risk and have the potential for loss as well as gain.
Data sources for returns and standard statistical data are provided by the sources referenced and are based on data obtained from recognized statistical services or other sources we believe to be reliable. However, some or all information has not been verified prior to the analysis, and we do not make any representations as to its accuracy or completeness. Any analysis nonfactual in nature constitutes only current opinions, which are subject to change. Benchmarks or indices are included for information purposes only to reflect the current market environment; no index is a directly tradable investment. There may be instances when consultant opinions regarding any fundamental or quantitative analysis do not agree.
The commentary contained herein has been compiled by W. Reid Culp, III from sources provided by TAGStone Capital, as well as commentary provided by Mr. Culp, personally, and information independently obtained by Mr. Culp. The pronoun “we,” as used herein, references collectively the sources noted above.
TAGStone Capital, Inc. provides this update to convey general information about market conditions and not for the purpose of providing investment advice. Investment in any of the companies or sectors mentioned herein may not be appropriate for you. You should consult your advisor from TAGStone or others for investment advice regarding your own situation.