Tax Smart Investing Blog Pt1

Marshall Rathmell |


Tax Smart Investing Part 1

Investors across the globe put their money into the markets wanting a positive experience.  The decisions they make impact whether they have a positive experience or not.  A mistake many of them make is focusing on things that they cannot control and ignoring things they can control.  While I have never heard of someone trying to increase their tax burden, many investors do by not positioning their investments in a tax smart way (something you can control).   Tax smart investing makes sense but instead of showing up as a positive number on a page (which most investors look for) it is hidden in the lack of tax burden that you don’t see.

As a firm that focuses on after tax return for our clients, Lindsay Birchfield and I were invited by Advice Chaser to give a seminar to their audience on some things to consider for tax smart investing.  I must warn this does involve some technical tax information that I have tried to simplify but can still be confusing.

In this first part we understand the different account options most households have and the impacts that your choice of investments in each one can have:

  1. The tax impact of the accounts you use-
    1. Traditional IRAs and employer sponsored accounts like 401ks are nice in the year that you contribute because they give you a deduction but eventually, they will come out as ordinary income.  A common mistake is putting a household’s highest earning investments and/or investments that can benefit from long term capital gains in a deferred account that can dramatically increase the taxes paid over one’s lifetime. 
    2. Roth accounts that grow tax free are a great location for high growth, high income, and investments that tend to delay your annual tax filing.
    3. Non-retirement accounts benefit from lower Long Term Capital Gain (LTCG) tax brackets when you hold the investment past a year. 
  2. The different tax impacts of asset classes
    1. Fixed income- While value does fluctuate some due to interest rate changes a primary earning function is interest that causes ordinary income.  Fixed income is necessary in a household portfolio to provide a ballast when the equity markets go down.  In good times (which is more often than bad one’s) your fixed income can cause a drag on the portfolio and ordinary income in the current year.  Deferred accounts are a preferred location for fixed income because you defer the taxation of interest that will be ordinary any way and aren’t excessively increasing that portion of your future taxes.
    2. Real Estate Investment Trusts (REITs)- Another investment that produces significant ordinary income are REITs.  Unlike fixed income REITs are volatile and have a high long term expected return.  Another tax concern for REITs is that they frequently get extensions to file their taxes which causes the funds they hold to file an extension, the brokerage accounts you hold them in to delay sending you 1099s and push you later in the tax season than you may want to be to have your tax return completed.  Roth accounts are a preferred location for REITs as you are converting the ordinary income tax to no tax and alleviating the filing delay they may cause.
    3. Equity- Focusing on the stocks that are expected to have long term capital appreciation instead of high dividends has numerous benefits.  Among those benefits is long term capital gains tax brackets when you invest them in non-retirement accounts.  This allows you to strategically recognize the gains as you need to or choose to and use the lower tax brackets to your benefit.

In part 2 I will discuss:

  1. Tax loss harvesting
  2. Improving your cost basis when doing charitable giving