Tax oriented investments have become increasingly popular among investors looking to maximize after-tax returns. By structuring investments strategically, investors can utilize various tax-advantaged accounts and assets to minimize tax liability. This article will explore common tax-oriented investment strategies, including utilizing retirement accounts, holding investments long term, asset location, loss harvesting, and more. Proper tax planning is crucial for long-term investing success. Read on to learn key tips on structuring a tax-efficient investment portfolio.
Use Retirement Accounts for Tax Deferred Growth
Tax-advantaged retirement accounts like 401(k)s and IRAs allow investments to grow tax-deferred. This means no taxes are owed on capital gains, dividends, or interest until funds are withdrawn. By maximizing annual contributions to retirement accounts like 401(k)s and IRAs, investors can shield a significant portion of their portfolio from current taxation. For example, in 2023 the contribution limit for 401(k)s is $22,500 plus a $7,500 catch-up contribution for those over age 50. The IRA contribution limit is $6,500 plus $1,000 catch-up. Fully funding these accounts with tax oriented investments can lead to substantial tax savings over time.
Hold Investments Long Term for Lower Taxes
For investments held outside of tax-deferred accounts, holding them long term can generate substantial tax savings. In the U.S., long term capital gains tax rates are far lower than short term rates. For example, in 2023 short term capital gains tax rates can be as high as 37% while long term capital gains max out at 20%. By holding investments like stocks for over one year before selling, investors can cut their tax bills nearly in half. This incentive to hold long term makes tax oriented investing strategies like buy-and-hold investing popular.
Strategic Asset Location to Maximum Tax Efficiency
Placing certain assets in taxable vs. tax-deferred accounts can optimize after-tax returns. As a general rule, the most tax-efficient assets like broad index funds should be placed in taxable accounts. Bonds and real estate investments that generate ordinary income should go in retirement accounts. Actively managed funds with higher turnover and low-dividend stocks also belong in tax-deferred accounts. Proper asset location takes into account the tax treatment of different asset classes and places them strategically to limit annual taxable distributions.
Loss Harvesting to Offset Gains
Loss harvesting involves selectively selling securities at a loss to offset realized capital gains. For example, if an investor realized a $10,000 capital gain by selling Stock A, they could sell Stock B at a $10,000 loss to offset this. The $10,000 capital losses directly reduce the taxable capital gain amount. Loss harvesting can provide investors with valuable tax deductions to apply against investment gains. Monitoring investments for loss harvesting opportunities is an important ongoing component of tax oriented investing.
Tax oriented investing seeks to minimize taxes and maximize after-tax returns through strategic structuring. Key strategies include maximizing tax-deferred retirement accounts, holding investments long term, locating assets optimally, and loss harvesting. With proper tax planning, investors can keep more of their investment returns and compound wealth faster.