Raise your hand if you want to pay more taxes!
No one? Okay, let's talk about whether you're living up to that reality. You most likely know to take advantage of tax-deferred retirement accounts and other tax-favored options such as Health Savings Accounts. You've probably heard about Roth IRA conversions and how, in some circumstances, you might be able to pay some amount of tax today with the expectation of saving taxes later on.
But, if you have taxable investment accounts in addition to tax-deferred accounts, how well are you managing your overall tax situation? If you aren't quite sure how your investment income will be taxed, you may be leaving money on the table.
SWA has always believed in investing client funds in a tax-efficient manner and does so by using mostly passively managed investment options and limiting trading turnover. By doing so, we can take greater control over the timing and amounts of realized capital gains. But we don't stop there – the next level of tax management is called "Asset Location."
Asset Location is a method of allocating your investment portfolio across your different account types in an effort to improve the performance of your portfolio, net of taxes. Certain types of so-called qualified investment income (e.g., qualified dividends and long-term capital gains) are taxed at lower rates than non-qualified income (e.g., interest, short-term capital gains, Real Estate Investment Trust dividends). No matter which tax bracket you land in, non-qualified income is taxed at a rate at least 10% higher at the Federal level than qualified income. Therefore, the logic of an Asset Location Strategy is to position your investment assets between your taxable and tax-deferred accounts in a way which will be more tax-friendly over time. Although it varies based on each client's situation, this could result in higher after-tax portfolio growth of 0.2%-0.5% per year. The key is that you incorporate all of your investment assets in this strategy, otherwise you cannot expect to realize the full benefits.
Many investors and investment managers are still focused on outdated ideas on how to manage their money, still believing that they can pick the next hot stock or successfully time moves in and out of the market. While there are always going to be a small group who do this successfully, there is an overwhelming amount of research (and personal experience) that the net result is much more likely to be higher fees and higher taxes on what you do earn. Instead, we should be focusing on the things we can actually control and understanding the tax code is a critical part of this.
If you need help in investing your money in a tax-effective manner, contact us now before another tax year slips away.