Don't "Beat the Market," Maximize Your Bottom Line
- Which assets belong in retirement accounts vs after-tax accounts
- How to navigate the new tax brackets
- The hidden tax benefits of losing money on an investment this year
- Why you may want to draw more income from your retirement account this year
The “bottom line” for investment management is often considered to be the portfolio’s rate of return. To increase this number, many will follow the misguided and often risky goal of “beating the market.”
In reality, the after-tax return number should be considered the bottom line. After all, it’s what you take home that counts. Maximizing tax efficiency in your portfolio is a much surer way to improve your bottom line, and you won’t lose your shirt in the process.
4 Strategies to Increase After-Tax Returns:
1) Investment Placement
In order to improve the tax efficiency of your portfolio, you can strategically place your investments in either a pre-tax account, (like your university retirement plan), or an after-tax account (like a brokerage account), based on the tax treatment of the investment. Different investments can generate income throughout the year, and how the proceeds are taxed varies based on the investment.
For example, taxable bonds generate interest income which is taxed at ordinary income rates. You have no control over the timing of the interest payments. When possible, taxable bonds should be placed in pre-tax accounts, because this allows you to defer paying taxes on the interest income this investment generates.
Similarly, mutual fund holdings generally pay annual capital gains distributions to investors and you have limited control on when the distributions are paid. These distributions are taxed at the capital gains rate, so this investment is also better suited in your pre-tax accounts as these taxes can also be deferred.
Municipal bonds are best suited in your after-tax accounts because the interest they pay is actually tax-exempt.
With individual stocks and ETFs, you do not recognize a taxable gain until after you sell your position. Some stocks will pay their investors a small dividend, but their taxation is minimal. Since there is not a substantial tax benefit to housing individual stock and ETF investments in a pre-tax account, you may want to consider this type of investment for an after-tax account.
2) Manage Capital Gains
Proactively manage your level of capital gains incurred in any given year to stay in control of your tax liability. Capital gains are taxes on the sale of appreciated stocks or equity funds, as well as, profits made on the sale of real estate (usually not your home), cars, boats and other items.
If your taxable income is less than $78,750 as a married couple in 2019, your capital gains tax rate is 0%. A 15% capital gains tax rate applies to married couples with income between $78,751 and $488,850. An additional 3.8% tax will be applied to married couples with incomes greater than $250k.
If you are selling a large holding that is highly appreciated, you may want to spread out the sale over multiple years to avoid going above the mentioned limits.
3) Count Your Losses
If you are facing a large capital gains tax, you can offset the gain by selling another investment at a loss. This technique is called “tax-loss harvesting.”
Prior to year-end, look for any assets that can be sold at a loss to offset any gains you incurred. The amount you can claim as a loss as a married couple is capped at $3,000 per year. If your loss is greater, any amount above $3,000 will carry forward to the next tax year.
Note that you cannot sell your investment for a loss and immediately repurchase the same, or a substantially identical investment, per the IRS’ “wash-sale” rule.
You can, however, use the proceeds from the sale to purchase similar assets and then reverse the trades after 30 days, if you want your original assets back in the portfolio. This allows your portfolio strategy to remain in place while avoiding the 30-day “wash-sale” rule.
4) Maximize New Tax Brackets
If you are drawing income from your pre-tax retirement plans, take advantage of the new lower and wider tax brackets. Married couples making $78,950 or less are in the lowest 12% tax bracket, $168,400 or less are in the 22% tax bracket, and the new 24% tax bracket extends to $321,450.
If your taxable income totals $60,000 after deductions, you may want to take another $18,950 of distributions from your pre-tax retirement plans to take full advantage of the 12% bracket. It’s unlikely that you’ll ever be in a lower bracket, so you may want to pay that attractive rate on your assets now.
Conversely, if you are approaching the upper limits of a bracket and are looking to fund a major purchase, you may want to use after-tax dollars as opposed to taking a retirement plan distribution that would bump you into a higher tax bracket.
Consult With a Professional at Filbrandt & Company
As a part of Filbrandt & Company’s Total Solution©, proactive tax planning is a large consideration when we provide comprehensive financial planning to our clients. We would be happy to discuss these proactive tax planning techniques and others in light of your overall financial plan. You can contact us at (800) 431-9740 or click to schedule a complimentary review.
The information provided is not, nor is it intended to be, legal advice. You should consult your attorney for advice regarding your individual circumstances.
Circular 230 Disclosure
We are required by Treasury Regulations (Circular 230) to inform the readers of this material that, to the extent that the information contained herein concerns federal or state tax issues, such information was not written or intended to be used, an cannot be used, for (1) avoiding federal or state tax penalties or (2) promoting, marketing or recommending to another party any transaction or matter addressed herein.
- To learn more about our investment process, read this report: The 3 Hidden Risks of Consolidating Your Retirement Accounts
- To learn more about the importance of seeking guidance from an independent fiduciary, read this report: Who Can You Really Trust With Your Financial Future?
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