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Does Your Advisor Do This? Strategies to Optimize After a Tax Return

When it comes to your financial strategy, what you keep is just as important as what you make. You can earn high amounts of money, but if you don’t account for taxes then you will essentially lose more money than you’d be comfortable with. A lot of people aren’t given the options or any ideas when it comes to tax planning so it’s important to be aware of strategies you can apply.

Here are 5 strategies to help you keep more of your money:

1. Determine the Type of Investment Vehicles You Should Use

When setting up your accounts you have several options available. You can either do a tax-deferred account where you pay tax later when the money is withdrawn, or you can choose a tax-free account where you pay tax up front and let the money grow tax-free.

In order to determine the best move for you, you have to consider the time horizon for these investments. If you’re going to be investing short-term (house, car, etc.) then it’s probably better in a taxable account. If you’re investing for the long term like retirement then a tax-free account is preferable to take advantage of compounding value that is tax-free. Knowing the right vehicle to place your investments in will help you get ahead in your financial planning.

If you already have a traditional 401k, consider maximizing the plan first before considering other investments to fully take advantage of the plan. Consider that you may not want to take a tax deduction now if you are in a higher tax bracket but take it later on when you are in a lower tax bracket. If you believe that you are going to be in a higher tax bracket later then opt for a tax-free account such as a Roth.

2. Tax Efficient Ways to Invest

There are numerous ways to invest. Even mutual funds have tax ramifications. If the investment manager buys and sells in the mutual fund, you will get tax passed on to you if you’re incurring capital gains. Active managers who are consistently buying and selling will have high capital gains at the end of the year, meaning higher tax. You don’t want to invest more money just before the capital gains get issued because you’ll get taxed at a higher rate. This also means that investing in lower turnover investments such as bonds will have lower gains and therefore lower tax.

On another note, when you go to pay taxes on for investments there are dividends. There are two types, qualified dividends or non-qualified dividends. To put it simply, stocks that can pass through as qualified dividends will pass at a lower tax rate compared to non-qualified dividends which will be taxed at the ordinary rate. Be sure to consult your financial advisor on how to take advantage of these dividends.

3. High-Cost Tax Method

When you start to invest, you will choose a type of tax method. One of these tax methods is the high-cost tax method. A lot of people use an average cost method, meaning that if you decide to sell your funds later on, your gains will be determined by an average cost method. However, using an average cost method will usually give you less money than you can get because you are only getting gains based on the average cost rather than the higher cost.

4. Tax Loss Harvesting

Tax loss harvesting shouldn’t be just done at the end of the year. Throughout the year, your investments will gain unrealized gains and losses. They are unrealized because you must sell something to actually get the benefit. What you can do when you have unrealized gains is to sell all the funds and buy a similar fund at the exact same time. You then wait the required 30 days to repurchase the original fund. This way you avoid the wash sales. So what happens after 60 days you’ll have the exact same holdings primed for when the market takes off.

During the end of the year, you may have double-digit returns and were able to turn unrealized gains into real gains due to this strategy. It also translates to huge tax savings because you don’t pay any taxes when any of the bonds have been sold. Of course, you do have to be aware that investments don’t go up all the time, there are times where they will go down.

5. Lowering the Tax Bracket Near/In Retirement

This strategy comes into play when you’re near 60 and 70. If you invest in a tax-deferred account, you do get the benefit of building up your investments tax-free until withdrawal. However, the government wants required minimum distribution at age 70. So 401ks, qualifying accounts, and Social Security are usually maximized at 70. If all of them are taken together at the same time, then your tax bracket doesn’t really change. Often, you’ll even go to a higher tax bracket.

However, if you decide to retire at 65 and don’t work for the next five years, then you can go to a very low tax bracket. In some cases, you don’t really need to wait until age 70 to get from your qualifying accounts. So you want to fill up buckets in lower taxes for those five years, then at age 70, your tax bracket will go up a little due to distributions. This means that you’ll set yourself up for lower taxes even if it goes a little higher when you reach 70 years old.

During these five years, you may want to pay taxes earlier due to the low rate. You can also use the strategy to convert money in a low tax bracket into a Roth account to allow the money to grow tax-free. You’ll pay less tax, and the money can later be set up for family members like a spouse, child, or grandchild.


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Larry Heller, Not Your Average Advisor.

 

A CFP® (Certified Financial Planner) and a former CPA.

Has helped solve complex financial planning for 20+ yrs.

Member of Wealth Management Think Tank.

A financial advisor think tank that meets monthly to discuss investment strategies and planning opportunities.

Larry is approached regularly by the respected journals.

“Journal of Financial Planning”, and “The Wall Street Journal”.