I know you have probably heard far too much about taxes lately and I am not going to review the recent tax bill here. I want to talk about tax strategies more generally.
“No man’s life, liberty or property are safe while the Legislature is in session.”
– Gideon J. Tucker, 1866
While many people spend their lives trying to find a ten bagger, it is generally more profitable to focus on more mundane – but more certain – opportunities. In other words, to become financially successful, both offense and defense are important. Due to the glamour and excitement of offense, people tend to ignore important defensive strategies. Both are vital to “winning the game.”
Taxes are one of these relatively boring yet important topics. Here are just a few items related just to investments that people frequently overlook:
Holding the wrong types of investments in the wrong accounts. If you have both taxable and tax-advantaged funds (IRA, 401(k), etc.), where you place various investments is important. Not only are some holdings inherently more tax efficient than others, but different tax rates apply. Placing the less tax-efficient investments in the sheltered accounts and the more tax-efficient investments in the taxable account can make a large and meaningful difference.
Maximizing tax-advantaged vehicles. Not only is maximizing the use of retirement plans and other tax sheltered vehicles important (including those for educational funding), but so is wisely choosing between the various options. In addition, there is a wide disparity in the tax efficiency of various investments held in a taxable account. Obviously it is more important to maximize after-tax return than it is to maximize before-tax return.
Using Roth vs. traditional retirement accounts optimally. The decision to save in a traditional IRA, 401(k), etc. vs. the Roth versions of those accounts (or the decision to convert into a Roth) is multifacted and extremely complicated but very important. (See Ruminations on Roth vs. Traditional IRAs for more information.)
Insurance vehicles. Generally, insurance products (like annuities) are not efficient vehicles for saving even given the tax advantages, but there are cases where they make sense.
Spending down assets in the optimal order. In retirement, there is an optimal way to liquidate investments for living expenses to minimize the tax bite. (See Tax-Efficient Spending from a Portfolio for more information.)
Taking advantage of low earning years or “room” in a relatively low tax bracket. Occasionally an individual will have a tax year when they have little or no income due to a sabbatical, job transition, or a brief time after retirement before pensions and social security begin. There is an opportunity to use the low bracket to save taxes in the future.
Maximizing the use of the step-up in basis. Property is inherited as though the recipient bought it at the current value. This can lead to large tax savings in many situations.
Harvesting losses. As investments rise and fall in value there are opportunities to take losses to offset against gains and to a limited extent against ordinary income.
Gifting the best assets. Whether to charity or to family, some gifts are better than others from a tax perspective. (See Charitable Giving for more information.)
As you can see, this is a very complex topic. If you are one of our clients, we are monitoring all of these issues for you but if you have any questions, please feel free to call or email us.