Are Tax Inefficiencies Costing You Money and Impacting Your Retirement Goals? Advice for the Tax-Conscious Investor.

Concerned about keeping your investment taxes low? Surveys indicate that over 70% of Americans are concerned that rising taxes will diminish their future savings. Unaddressed tax inefficiencies in your investment portfolio and financial plan could also erode how much you have left to live on after taxes. Strengthening your investment strategy can help you maximize your after-tax income and savings.  Below are some actions you can take to help save on investment taxes and improve your success at reaching your retirement goals:

Choose and match the right investments for your different account types – It is important to match different types of accounts you have (such as taxable or retirement accounts) with particular investment strategies. To reduce taxes, consider the following factors when deciding which investments to put (and not to put) into your respective accounts.

• Taxation of Interest.
• Taxation of Capital Gains.
• Taxation of Capital Losses.
• Taxation of Dividends.
• State and Local Taxes.
• Foreign Taxes Paid.

Regularly contribute to tax-efficient accounts – Making increased contributions to retirement accounts (and there are many options involved here, depending on age and circumstances) can help put you on track to be prepared for retirement.

Probably the best way to accumulate funds for retirement is to take advantage of IRAs and employer retirement plans. The reason these plans are so important is that they combine the power of compounding with the benefit of tax-deferred (and, in some cases, tax-free) growth. For most people, maximizing contributions to these plans makes sense, whether on a pre-tax or after-tax (Roth) basis. A key part of a tax planning strategy is reducing taxes from withdrawn funds from tax-deferred accounts, such as 401(k)s or IRAs.

Focus on the order or sequence in which you invest in your accounts – In general, you should max out your 401k/403b/457b each year, then your Backdoor Roth IRA, and then your individual/joint taxable account.

Be tax-conscious and use tax-efficient investments and strategies – Keep turnover (trading) low in taxable accounts and tax-inefficient investments in retirement accounts (NOT in taxable accounts). Also, your mutual funds may have high turnover ratios, which can cost you at tax time, so be aware of this and try to avoid and eliminate mutual funds that fall into this category. A mutual fund turnover ratio or turnover rate is the percentage of mutual fund holdings bought and sold in any calendar year. Some funds hold equity positions for less than 12 months, meaning their turnover ratios exceed 100%. Turnover rates can vary significantly between different types of mutual funds (and exchange-traded funds) and can significantly impact taxes. Studies have shown that taxes may reduce portfolio returns by 2% on average for investors who do not account for them when making investment decisions.

Consider converting tax-deferred funds to a Roth IRA or Roth employer-sponsored retirement savings plan – While the conversion amount is taxable in the year it is converted, the upside is that these Roth accounts let your retirement savings grow tax-free and are not taxable when withdrawn (as long as you’re 59½ or older and have owned a Roth for at least five years). It’s important not to let the upfront tax bill prevent you from moving your retirement funds from accounts that are taxed no matter when you take them out into tax-free accounts. The point is to not be shortsighted at the expense of being hit with large tax payments in retirement.

Consider spousal IRAs – A spousal IRA permits a spouse who doesn’t work or earn income to fund an individual retirement account. Understanding the rules and how income thresholds affect tax deductions is important.

Maximize charitable contribution deductions – One way to do this is by selecting highly appreciated assets when contributing to charitable causes. This can reduce your tax bill and increase your deduction. Plenty of strategies are available to discuss further, depending on specific situations.

Conclusion

Because everyone has a different situation and many strategies are available, you should determine what’s best for you based on your specific financial profile and situation. Improving your future financial strength by minimizing your investment taxes can significantly impact your golden years.