Whether you’re saving, investing, spending, bequeathing, or receiving wealth, there’s scarcely a move you can make without considering how taxes might influence the outcome. But how do we plan when we cannot know?

The particulars may evolve, but it seems there are always an array of tax breaks to encourage us to save toward our major life goals. However, it remains up to us to make the best use of these “tools of the trade.” Today, let’s cover what those tools are, as well as how to integrate them into your investing and financial planning.

The good and bad news about saving for retirement is how many tax-favored savings accounts exist for this purpose. There are a number of employer-sponsored plans, like the 401(k), 403(b) and SIMPLE IRA. There also are individual IRAs you establish outside of work. For both, there are traditional and Roth structures available.

In any of these types of retirement accounts, your dollars have the opportunity to grow tax-free while they remain in the account. This helps your retirement assets accumulate more quickly than if they were subject to the ongoing taxes that taxable accounts incur annually along the way (such as realized capital gains, dividends, or interest paid).

Tax treatments for different types of retirement accounts can differ dramatically from there. For some, you can make pre-tax contributions, but withdrawals are taxed at ordinary income rates in the year you take them. For others, you contribute after-tax dollars, but withdrawals are tax-free—again, with some caveats. Each account type has varying rules about when, how, and how much money you can contribute and withdraw without incurring burdensome penalties or unexpected taxes owed.

The Healthcare Savings Account (HSA) offers a rare, triple-tax-free treatment to help families save for current or future healthcare costs. You contribute to your HSA with pre-tax dollars; HSA investments then grow tax-free; and you can spend the money tax-free on qualified healthcare costs. That’s a good deal. Plus, you can invest unspent HSA dollars, and still spend them tax-free years later, as long as it’s on qualified healthcare costs. But again, there are some catches. Most notably, HSAs are only available as a complement to a high-deductible healthcare plan, to help cover higher expected out-of-pocket expenses.

Employers also can offer Flexible Spending Accounts (FSAs), into which you and they can add pre-tax dollars to spend on out-of-pocket healthcare costs. However, FSA funds must be spent relatively quickly, so investment and tax-saving opportunities are limited.

529 plans are among the most familiar tools for catching a tax break on educational costs. You fund your 529 plan(s) with after-tax dollars. Those dollars can then grow tax-free, and the beneficiary (usually, your kids or grandkids) can spend them tax-free on qualified educational expenses.

The Donor-Advised Fund (DAF) is among the simplest, but still relatively effective tools for pursuing tax breaks for your charitable giving. Instead of giving smaller amounts annually, you can establish a DAF, and fund it with a larger, lump-sum contribution in one year. You then recommend DAF distributions to your charities of choice over future years. Combined with other deductibles, you might be able to take a sizeable tax write-off the year you contribute to your DAF—beyond the currently higher standard deduction. There also are many other resources for higher-end planned giving. For these, you’d typically collaborate with a team of tax, legal, and financial professionals to pursue your tax-efficient philanthropic interests.

There also are a variety of tax-friendly incentives to facilitate general “rainy day fund” saving, and to offset crisis spending. These include state, federal, and municipal savings vehicles; along with targeted tax credits and tax deductions.

Last but not least, a bounty of trusts, insurance policies, and other estate planning structures help families leverage existing tax breaks to tax-efficiently transfer their wealth to future generations.

With ongoing negotiations over the tax treatment on inherited assets, families may well need to revisit their estate planning in the years ahead. Come what may, there’s always an array of best practices we can aim at reducing your lifetime tax bills by leveraging available investment tools to maximum effect. We’ll cover those next.

It’s one thing to have the tools just described. It’s another to make best use of them.

In short, tax planning is an ongoing campaign, staged on multiple fronts. One of the most powerful ways to ward off excess taxes is to be tax-wise about your investing. And yet, few investors take full advantage of the many opportunities available at every level. These levels include how you manage your investment accounts, select individual holdings, and buy and sell those holdings along the way.

Are you doing all you can to build, manage, and spend down your taxable and tax-sheltered accounts for maximum lifetime tax-efficiency?

Are you being deliberate about selecting tax-efficient vehicles? Even when different funds share identical investment objectives, some may be considerably better than others at managing their underlying holdings. Seek out fund managers with solid tax-management practices, including:

 

Like the fund managers you choose, are you also being patient and deliberate about your trading? Do you avoid excessive trading and short-term capital gains (currently taxed at higher rates)? Are you guided by a personalized investment plan? Bottom line, the fewer trades required to stick to your investment plan, the better off you’re likely to be when taxes come due.

Having an investment plan also facilities your or your advisor’s ability to identity and make best use of tax-loss and tax-gain harvesting opportunities when appropriate.

Tax-loss harvesting typically involves:

1.     Selling all or part of a position in your portfolio when it is worth less than you paid for it.

2.     Reinvesting the proceeds in a similar (not “substantially identical”) position.

3.     Optionally returning the proceeds to the original position after at least 31 days have passed (to avoid the IRS “wash-sale rule”).

You can then use any realized capital losses to offset current or future capital gains, without significantly altering your portfolio mix.

It’s worth noting, tax-loss harvesting typically lowers a harvested holding’s cost basis. So contrary to popular belief, you’re usually postponing rather than eliminating taxable gains. Why bother? More time gives you more control over when, how, or even if you’ll realize the gains. For example, you could wait until tax rates are more favorable, or reduce embedded gains over time through gifting, charitable giving, or estate planning tactics. 

Tax-gain harvesting involves selling appreciated holdings to deliberately generate taxable income. Why would you do that? Remember, your goal is to minimize lifetime taxes paid. So, especially once you’re tapping your portfolio in retirement, you may intentionally generate taxable income in years when your tax rates are more favorable. Basically, you’re sacrificing a tax return battle or two, hoping to win the tax-planning “war.”

Managing for tax-efficient investing is just one way we help families reduce their lifetime taxes. We also help integrate all of the above into your broad financial interests. Following are just a few life events that can pose potential tax-planning challenges and opportunities:

The above scenarios represent only a handful of the tax-planning events you might encounter throughout your life. Whether you’re building, preserving, or spending your wealth, tax-planning remains integral every step of the way. Each financial move you make can and should be leveraged for tax efficiencies as described. Better still, a seasoned tax-planning professional can combine these parts into an integrated whole as you pursue lifelong tax efficiency.

Put another way, ideal tax planning integrates seamlessly with all your greater financial plans. This can get complicated—like a juggling act, in which we must keep an eye on each item as well as the big-picture results.

Could you use an experienced hand to keep your total wealth at play? We’re here to help!

Have a wonderful day,

David