Article

Tax-Efficient Investing: 5 Strategies to Know About

A group of colleagues meeting to discuss strategies

Last year represented a turbulent period for investors, with both the stock market and the bond market down double-digit percentages. The fact that this follows more than a decade of rarely interrupted bull market glee leaves many portfolios with a unique bouquet of gains and losses. The ever-present need among investors for tax-efficient strategies is therefore accompanied by a genuine opportunity to reduce tax bills going forward. Below are some strategies to consider.

Tax-loss Harvesting

Tax-loss harvesting is a way to reduce taxes by selling an underperforming asset and using the loss to offset other gains. Think of it like this: You sell an investment that's underperforming and losing money. Then, you use that loss to reduce your taxable capital gains and potentially offset thousands of dollars of your ordinary income. Capital losses can offset capital gains.

With the markets currently down, it’s a potential way to cut taxes and reduce a position that isn’t ideal. Selling an investment when it’s below the price you paid for it may not be an ideal scenario, but it provides a silver lining in the current market and could be a useful tool.

Charitable Giving

Following heightened volatility across the markets, it may be an unusually opportune time to consider how charitable giving can improve a tax position. Many portfolios today hold highly appreciated assets alongside positions with significant unrealized losses (with a solid chance that the latter are of the short-term variety). Donating winners in the portfolio provides dual benefits: first, for the purposes of write-offs, the investor gets credit for the (appreciated) market value of the assets rather than the book (cost) value; second, the taxes associated with the gains will be avoided. Assets held at a loss can also represent a dual tax opportunity when it comes to charitable giving, the difference being that the investor ought to sell those positions.

Account Conversions

For individuals who hold assets in a traditional IRA, and who anticipate higher rates for themselves in the future when receiving IRA distributions, moving assets into a Roth IRA can create significant tax savings over their lifetime. By converting assets to a Roth, an investor eliminates the risk of significantly higher tax rates being applied in the future when the assets are drawn from the account.

Retirement Distributions

While some distributions from retirement accounts become mandatory at age 59 ½, a tax-diversified portfolio provides ample flexibility regarding the pattern of withdrawals. The source of funds for retirement spending – both at the account level and at the individual investment level – can have a significant impact on the overall amount of taxes paid over the course of retirement. While the optimal strategy will look different for every investor (depending on their income level and on their spending and estate goals), what’s important to know is that conventional wisdom on the topic (that one ought to draw exclusively from taxable accounts first, while allowing tax-advantaged accounts to grow for longer) may lead to unnecessary taxes.

Tax Diversification

In general, splitting investment assets between tax-deferred (funded with pre-tax dollars, taxed later when withdrawn) and tax-free (funded with after tax dollars, withdrawn tax free later) accounts will mitigate some of the inherent uncertainty regarding an individual’s future effective tax rates. In other words, opting to diversify between both types of accounts reduces the risk of reaching retirement having selected the less tax-optimal vehicle between the two. Finally, by including taxable investment accounts into the mix, investors will add a degree of flexibility in terms of the timing and sizing of withdrawals from your overall investment portfolio. A portfolio that includes all three types of taxability will be well positioned to support a broader range of potential future spending needs.


If you have questions on any of these topics, please reach out to your 1834 relationship team.