Investing certainly has its advantages. But when it comes to tax time, things can get a bit more complicated. As with all aspects of finance, it pays to strategize, and asset location is a strategy that has proven to be quite fruitful for those looking to enhance their investment tax efficiency.
Asset location is all about maximizing the potential returns of your investments while minimizing the amount of taxes you have to pay in the process. Different types of assets are taxed in different ways, so the placement of these assets can play a major role in how much you end up paying to the government.
Here are 5 asset location strategies to enhance investment tax efficiency and help you keep more of your hard-earned money:
- Place High Yield Assets in Tax-Deferred Accounts
One of the most basic asset location strategies involves placing high-yield or income-generating assets in tax-deferred accounts such as traditional IRAs or 401(k) plans. This strategy aims at protecting these assets from tax liability that would otherwise be associated with regular income taxes.
The key point to remember is that tax-deferred accounts offer investors a tax shelter that can lead to improved returns on investment over the long haul.
- Use Taxable Accounts for Tax-Efficient Investments
Conversely, tax-efficient investments such as index funds, municipal bonds, and exchange-traded funds (ETFs) can be placed in taxable accounts. These investments do not generate significant income or capital gains, and, therefore, have relatively low tax liability.
Placing these investments in taxable accounts offers investors the opportunity to maximize after-tax returns while keeping tax liability low.
- Manage Asset Location Across Multiple Accounts
Another strategy involves optimizing asset location across several accounts such as individual retirement accounts (IRAs), 401(k) plans, and taxable accounts. This strategy ensures that investors maximize tax efficiency by placing assets that are most tax-inefficient in tax-sheltered accounts, while at the same time positioning tax-efficient investments in taxable accounts.
When managing asset location across multiple accounts, it is necessary to consider the tax implications of selling and rebalancing, as this can have a significant impact on the overall tax situation.
- Tax-Loss Harvesting
Tax-loss harvesting involves selling investments that have lost value, and realizing losses that can offset capital gains and other investment income. It is particularly essential for investors in high tax brackets as it allows them to reduce the overall tax burden while maintaining their overall investment strategy.
Additionally, the IRS permits the ability to carry forward unused losses indefinitely to reduce tax liability in future years.
- Location is Key
Finally, an asset’s location regarding its tax liability is often crucial. For example, municipal bonds generate tax-free income, and if held in a taxable account, there would be a tax liability for its tax-free income. Similarly, ordinary income, such as interest from CDs and corporate bonds, would be best deployed within tax-deferred accounts since they are taxed at high rates.
Speak to your financial advisor today to learn more about how they can help you optimize your asset location strategies to enhance your investment tax efficiency.
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This information has been obtained from sources considered to be reliable, but we do not guarantee that the foregoing material is accurate or complete. Any opinions are those of the author, and not necessarily those of Raymond James. Every investor’s situation is unique and you should consider your investment goals, risk tolerance and time horizon before making any investment. Investing involves risk and you may incur a profit or loss regardless of strategy selected including diversification and asset allocation. Be sure to contact a qualified professional regarding your particular situation before making any investment or withdrawal decision. This material is for general information only and is not intended to provide specific advice or recommendations for any individual. Financial and investment planning inherently involve potential tax and legal implications, with which we are generally familiar. We do not, however, practice as lawyers or CPAs and cannot give specific legal or tax advice. You should always consult with your tax advisor, or your attorney, when making complicated legal or tax decisions, however, we’re glad to work with your tax or legal professional to help you meet your financial goals. Raymond James financial advisors do not render advice on tax or legal matters.
Income from municipal bonds is not subject to federal income taxation; however, it may be subject to state and local taxes and, for certain investors, to the alternative minimum tax. Income from taxable municipal bonds is subject to federal income taxation, and it may be subject to state and local taxes. CDs are insured by the FDIC and offer a fixed rate of return, whereas the return and principal value of investment securities fluctuate with changes in market conditions.