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The Art of Tax Planning: Optimizing Your Investments for Lower Taxes

FAQ: How Can I Structure My Investments and Assets to Minimize My Tax Burden?

Structure your investment portfolio to potentially minimize tax burdens and enhance long-term wealth growth through insightful tips and professional guidance. With a little bit of planning, you could lower your tax payment by taking a proactive approach.

What comes to mind when you hear the word taxes? For many, thoughts of W-2s, income tax, and April 15th come to mind – and a feeling of dread filled with fears of inaccuracy missed deadlines and writing big checks to the IRS. But what if we told you that with a little proactive tax planning, you might be able to reduce the number of zeros on your check this year and years into the future?

Unlike tax preparation, which looks at past tax activity, tax planning focuses on the future.

It involves analyzing your financial situation, including income, expenses, investments, and future goals. The goal is to develop strategies to minimize your tax burden and maximize your after-tax income.

It is important to consult a tax professional and financial adviser about your specific situation so that they can customize a plan specifically for you.

Optimizing Asset Location

Optimizing asset location is exactly what it sounds like. It’s simply saving in the appropriate type of account to decrease your tax burden. Considering the different types of savings vehicles such as traditional vs. Roth IRA and 401(k) accounts, otherwise known as Traditional, can be a good place to start.

As a quick refresher,

  • Traditional IRAs/401(k)s: Contributions are tax-deductible and beneficial if you are in a higher tax bracket now.
  • Roth IRAs/401(k)s: Contributions are made with after-tax dollars, but withdrawals are tax-free, advantageous if you expect to be in a lower tax bracket in retirement.

Whether you chose Roth or Traditional depends on a few factors including your current tax bracket and expectations around your financial future. Traditional accounts benefit those in a higher bracket now, while Roth can be advantageous to those who expect to be in a lower bracket in retirement (tax-free withdrawals!).

While regular IRAs and 401(k)s have contribution limits, high-earners may have access to explore options like a backdoor Roth conversion or mega backdoor Roth conversion (if their employment plan allows) to move more money into tax-advantaged accounts. Almost anyone with a high-deductible health plan could benefit from triple tax advantages by saving in a health savings account (HSA). Contributions are usually tax-deductible, earnings grow tax-free, and qualified withdrawals are tax-free.

Advanced Options:

  • Backdoor Roth Conversion: For high-earners to move more money into tax-advantaged accounts.
  • Health Savings Accounts (HSAs): Offer triple tax advantages—tax-deductible contributions, tax-free growth, and tax-free withdrawals for qualified expenses.

Tax-Efficient Investment Selection

Another factor when considering ways to optimize a tax advantaged strategy is to ensure the type of investment appropriately matches the type of investment account. Investing in high-dividend stocks and actively managed funds should be done in tax-advantaged accounts as those investments may generate capital gains.

• High-Dividend Stocks and Actively Managed Funds: Best held in tax-advantaged accounts to avoid capital gains taxes.

Additionally, Index Funds and ETFs should be considered for taxable accounts because their low turnover minimizes taxable events, while municipal bonds might also be considered as an investment option as interest is tax exempt, but bonds may produce lower yields over time.
• Index Funds and ETFs: Suitable for taxable accounts due to their low turnover and minimal taxable events.
• Municipal Bonds: Interest is tax-exempt, though yields may be lower.

Advanced Strategies

A financial adviser could help you take advantage of techniques, such as tax-loss harvesting, delaying Social Security benefits, and exploring tax-deductible options.

Tax-loss harvesting is the process of selling an investment at a loss to offset the capital gains taxes on other investments that have been sold for a profit. The key to implementing this strategy is to stay invested by reinvesting the proceeds from the sale into a similar investment. This allows you to stay invested in the market while lowering your taxes.

Delaying Social Security benefits is another lever to consider, as it offers the potential of increasing payouts, lowering your taxable income; other options include exploring tax-deductible expenses like charitable contributions and taking advantage of available tax credits.

  • Tax-Loss Harvesting: Sell investments at a loss to offset capital gains taxes and reinvest in similar investments to stay in the market while lowering your tax bill.
  • Delaying Social Security Benefits: Can increase your payouts and reduce taxable income.
  • Exploring Tax-Deductible Expenses: Charitable contributions and available tax credits can significantly lower your tax burden.

Tax diversification through careful asset location and investment type are crucial but just one aspect of a well-rounded investment strategy. Additionally, it’s essential to consider factors like risk tolerance, investment goals, and time horizon.

Looking to learn more about the ways your investment structure impacts your taxes? Check out the article, “Tax Tips, Tools, And Answers For An Easier Tax Season” to get answers to some of your frequently asked questions, like, how do retirement plan and health savings account (HSA) contributions affect my tax bill and are my social security benefits taxable?

Always consult with a tax professional and financial adviser to tailor these strategies to your specific situation. By taking a proactive approach to tax planning, you can optimize your investment portfolio, minimize tax burdens, and enhance your long-term wealth growth.

Connect with OneDigital’s Wealth Management team to learn more.

Investment advice offered through OneDigital Investment Advisors LLC, an SEC-registered investment adviser and wholly-owned subsidiary of OneDigital. These materials are provided for informational and educational purposes only and do not constitute a recommendation to buy, sell, or hold any security, nor do they constitute legal, accounting, investment, or tax advice. The materials and the information provided are not designed or intended to be applicable to any person’s individual circumstances. These statements do not constitute an offer or solicitation in any jurisdiction. All included information and data are limited only to the inputs and other financial assumptions indicated.