Taxes: The Most Important Uninvited Guest at Every Financial Meeting
One topic I can’t escape in my line of work is the discussion of taxes. It seems like taxes start by peeking in, and then they end up walking through the door and wanting to be involved in every conversation. It could be they find me because I actually did taxes in a past life and bring insight…and maybe they just miss me. In all seriousness, taxes are a consideration for so many financial decisions. Nearly all of them!
That is why I believe in Tax Efficient Investing for all. With this strategy, you can maximize returns while minimizing taxes and keep more of your money where it belongs: in your pocket. Here are some important components to consider:
Tax-advantaged Accounts
It is important to utilize accounts like IRAs, 401(k)s, and Roth IRAs. Contributions to IRAs and 401(k)s are usually tax-deductible and the growth is tax-free. You will only be taxed on this money when you pull it out during retirement. Contributions to a Roth IRA are made with after-tax contributions, but withdrawals and growth may be tax-free.
Taxable Accounts
Money held in an investment or brokerage account that is not a retirement account is considered a taxable account. These accounts are available for withdrawal whenever you want, but you will pay taxes on any growth. Even if you leave the money in the account, you will pay taxes on any interest or dividends the account makes each year. Therefore, it’s important to structure these accounts so they are tax-efficient.
▪ Invest in tax-efficient funds: Exchange-traded funds (ETFs) are known for their tax efficiency. These funds are structured in a way that minimizes capital gains distributions. Many mutual funds can have sneaky, high capital gains distributions that will end up adding to your taxable income at the end of the year.
▪ Long-term strategy: Investments held for more than a year qualify for a lower capital gains tax rate. If you let your investments sit for a year or longer, you won’t pay as much tax on them if they grow. Minimizing portfolio turnover can have the same effect. Unnecessary buying and selling has the potential to increase your taxes without offsetting it with the gain you want to see. This is also something to keep in mind when rebalancing your portfolio.
▪ Tax loss harvesting: Sometimes your account has a bad year, and you lose money. The good news is that there is opportunity here. If you have losses in your account, you have the option of selling the investments that didn’t do well to offset capital gains and potentially lower your taxable income.
Thoughtfully spread your assets across taxable and tax-advantaged accounts. Finding the perfect combination will be specific to you and your goals. Pop tax-inefficient investments into the tax-advantaged basket and tax-efficient picks into the taxable basket.
What other Tax Strategies May Be Overlooked?
Health Savings Accounts:
If you have a high-deductible health plan, an HSA is one of the best ways to avoid paying taxes. Here is what I tell people: The maximum contribution per year for a family is $7750. This is a deductible contribution that will lower taxable income.
● Any interest earnings and investment growth from contributions are tax-free.
● Any medical expenses that are incurred can be paid using the HSA with no tax penalty.
So, the contributions and the withdrawals are tax-free AND there is no time limit for reimbursing yourself. For example, if you have a medical emergency in 2024 and you pay for it from your checking account, you can reimburse yourself from the HSA in 2026 if you want. Just be sure to keep your receipts. Another benefit of the HSA is that you can put it into an invested account to let it grow, and then just take it out when you need it.
Child and dependent care costs:
If the client pays for daycare or afterschool programs while they work, they can deduct a percentage of the cost. It doesn’t return much. The maximum credit for one child is $1050 and the maximum for two or more children is $2100, but it’s better than nothing!
Itemized Deductions:
In general people don’t take the time to keep track and add them up. Especially high-income earners. Utilizing itemized deductions can be advantageous, potentially exceeding the standard deduction. Numerous affluent individuals benefit from substantial deductible expenditures, such as mortgage interest, charitable donations, medical costs, property taxes, and state/local taxes.
Taxes may be the surprise guest at every financial discussion, but with a tax-efficient investing mindset, we can keep more money in our pockets where it belongs. If you have any questions on how to get organized and improve your financial strategy I encourage you to schedule a free consultation with me below.