Tax-Smart Investment Strategies


By Ryan Meacham,

Cornerstone Wealth Management

Many investors might wait until November or December to begin considering tax-saving strategies, but it’s not too early to start thinking about ways in which you can ease your tax burden. With some careful planning, you can legally reduce taxes owed to the IRS on investment gain.

  1. Increase contributions to tax-advantaged accounts
Putting money in retirement accounts that carry tax advantages will benefit you twice over. You’ll be saving money for your retirement while potentially lowering your tax bill.

For example, the contributions you make to a 401(k) are taken out of your paycheck before you are taxed on those earnings. Likewise, with a traditional IRA, your contributions may be tax deductible, which can further reduce your taxable income.

These tax advantages might also drop you into a lower tax bracket which doubly helps because it also lowers the amount you have to pay on gains from the sale of assets held under one year (short-term capital gains).

Finally, you benefit from these accounts in that the dividends and interest earned are only subject to taxes when you withdraw money in retirement. So as long as you keep the money in your plan and follow the rules, you likely won’t have to pay taxes on any returns until it comes time to withdraw.

  1. Focus on asset location
Asset location is just as important as asset allocation. Due to the tax advantages of retirement accounts, they are also a great place to keep bond funds or other income generating investments. The income these investments gain will be tax free until you withdraw.

Another recommendation to decrease your taxes on bonds is to buy municipal bonds. These are debt issued by state and local governments to fund projects and are usually exempt from federal and state taxes. By putting municipal bonds in your taxable account, you can get exposure to bonds without a big tax hit. You wouldn’t want to place these bonds in your retirement account, though, because you couldn’t capitalize on the tax-exempt benefits of these bonds since the interest and capital gains in the retirement account are already tax-deferred. It is better to take advantage of the tax-exempt nature of municipal bonds in a taxable account.

Another strategy is to transfer an aggressive investment into a Roth IRA. After you make the transfer, you have until October 15


of the following year to monitor the investment and re-characterize it if necessary to avoid paying the taxes on a loss. Yet, if the investment pays off, you could have a large gain that will never be taxed.

  1. Sell losers, keep winners
If you have an investment that is down, don’t be afraid to cut your losses. Not only are you ridding yourself of a sinking ship, but you are also lowering your tax burden as it will offset the gains you’ve realized from your winning investments, which means fewer gains to report to the IRS.

And if you have losses on your stocks, you may be able to take up to $3,000 in losses to deduct against your ordinary income. You can also carry forward any losses on investments incurred over $3,000 from earlier years.

The easiest way to lower, or at least delay, your taxes is simply by not selling your winning investments. Or if you do, at least wait until you’ve owned the shares for one year. Long-term capital gains are taxed at significantly lower rates than short-term capital gains.

For example, if you have owned a stock for ten months and it has appreciated, but you think there is even more potential, it would behoove you to hold on to it for at least another two months to lock in that long-term rate. Conversely, if you think the stock has over-achieved or reached its max potential, it might be best to lock in profits, regardless of the tax consequences.

  1. Distributions in retirement
Once you reach retirement, there is a profound shift in risk exposure. The main reason for this is the shift from positive to negative cash flow. Despite this increased volatility, there are things you can do to guard against it.

You can affect your tax rate by strategically picking where you take your distributions from. If you want to avoid moving into a higher tax bracket, take more distributions from your Roth IRA, which is tax-free. On the other hand, if you are in a lower tax bracket, do not take from the Roth that year. In the long run, having such flexibility can make a big difference.

It is never too early to consider the tax implications of your portfolio. And following just these few steps can make you more tax-savvy, which in the end, means more money in your pocket.