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4 Tax Management Tips for Investors

It’s nearly tax season — the IRS will begin accepting and processing 2020 tax-year returns next Friday, February 12 — but keep in mind that for investors, tax management is a year-round endeavor.

Improper tax management can cost you more than a quarter of your long-term return, severely limiting spending power in retirement. The good news is that taxes can be managed. Get full insights with our free downloadable guide 5 Tax Hacks Every Investor Should Know.

For now, here are four key areas where you can place your tax focus.

Tax Efficiency

Thousands of potential investment vehicles exist today, each with radically different tax implications. Choosing and using tax-efficient investments is a vital first step toward keeping more of your money. Here are some general guidelines when it comes to common investment vehicles.

  • Mutual Funds are notoriously bad in terms of tax management.
  • Exchange Traded Funds (ETFs) are generally more tax efficient than mutual funds.
  • Individual Stocks can be the most tax-efficient way to gain exposure to equities.
  • Bond ETFs and passive bond mutual funds are generally more tax efficient than actively managed bond mutual funds, but the tax treatment of income generated from bonds differs from that of equities.
  • Real Estate Investment Trusts (REITs) dividends are generally taxed as ordinary income to shareholders.

You can track and analyze all of your investment accounts (and, in fact, all other financial accounts) using Personal Capital’s free online tools. Millions of people use this technology to identify their ideal target allocation, designed to minimize risk and maximize returns. With the tools, you can also uncover hidden fees in your mutual fund, investing, and retirement accounts. Financial institutions charge annual fees on mutual funds and other assets. Over time, these fees add up and can dramatically reduce your lifetime savings.

Get Clarity on Your Financial Accounts

Tax Location

If you have multiple investments, do you consider the most appropriate account for each of your assets? If not, you should.

Each of your accounts has unique tax characteristics, and if you understand these characteristics, you can place your assets in the most advantageous accounts, thereby minimizing your tax liabilities. This is called tax location. Depending upon the underlying characteristics of the investment, strategically placing it in either a taxable, tax-deferred, or tax-exempt account may improve your annual return.

So what securities go where? One general rule is to place high-yield stocks in tax- deferred or -exempt accounts, like IRAs and Roth IRAs, and low-yield or no-yield stocks in taxable accounts. Fixed income investments are a little trickier. It’s good to keep in mind, optimizing around long-term growth rates and tax rates can get very complicated, so you should consult a professional.

Tax-Loss Harvesting

Tax-loss harvesting is the process of intentionally realizing losses to offset realized gains. It’s slightly counterintuitive — after all, you’re supposed to sell high, right? But the idea is not to eliminate exposure entirely; it’s only a temporary sale to reduce your tax bill, after which you buy back the same stock.

Tax-loss harvesting works even if you want to maintain exposure to the stocks that have lost value, but there are some rules. To avoid the “wash sale” rule, you cannot repurchase the same or a substantially identical stock within 30 days before or after selling at a loss. Even if you don’t have any gains to offset, you can deduct up to $3,000 in losses from your taxable income, resulting in a higher net after-tax return.

To learn more, read our free Guide to Tax-Loss Harvesting.

Roth Conversions

Starting in 2010, it became possible for high-income individuals to convert their traditional IRA accounts to Roth IRAs. This can be an important decision, and it’s worth spending the time to figure out if it is right for you. Generally speaking, if you expect your tax rate to be higher, then you may want to consider converting. If you expect it to be about the same, a more detailed analysis is required. Often there is still an advantage to the Roth conversion because the converted money will be able to grow tax free while the opportunity cost from the taxes paid from post-tax accounts will be subject to taxes on dividends and capital gains along the way.

A Roth conversion can also generate a large tax bill, and it matters how you go about paying it. A Roth conversion only makes sense if you can pay the tax bill with funds from an outside non-retirement account.

The content contained in this blog post is intended for general informational purposes only and is not meant to constitute legal, tax, accounting or investment advice. You should consult a qualified legal or tax professional regarding your specific situation. Keep in mind that investing involves risk. The value of your investment will fluctuate over time and you may gain or lose money.

Any reference to the advisory services refers to Personal Capital Advisors Corporation, a subsidiary of Personal Capital. Personal Capital Advisors Corporation is an investment adviser registered with the Securities and Exchange Commission (SEC). Registration does not imply a certain level of skill or training nor does it imply endorsement by the SEC.

Craig Birk leads the Personal Capital Advisors Investment Committee and serves as Chief Investment Officer. His focus is translating improvements in technology into better financial lives. Craig has been widely quoted in the Wall Street Journal, Bloomberg, CNN Money, the Washington Post and elsewhere. Prior to Personal Capital Advisors, he was a leader within the portfolio management team at Fisher Investments, helping assets under management grow from $1.5 billion to over $40 billion. Craig graduated from the University of California at San Diego and has earned the Certified Financial Planner® designation.
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