Quelling April Aftershocks, Tax Efficient Investing For Gen X
Do April showers bring May flowers or does the April tax filing date bring us face-to-face with our non-flowery tax realities? According to Bloomberg, the average federal income tax rate in 2015 was over 10 percent, but for a family earning over $100,000 that rate can quickly climb. After adding the average 9.5 percent paid for Medicare and Social Security taxes as well as any state income taxes, the tax pain a family earning over $100,000 felt this tax season was far greater than Bloomberg’s average. Paying Uncle Sam a big chunk of earnings in April leaves Generation X (mid-30’s to mid-50’s) with more questions than blooms in May, making this month the perfect time to discuss tax efficient investing.
As we start to accumulate wealth, our financial lives become more complex. We find ourselves with assets in different locations – from 401(k)s, IRAs, and annuities to brokerage and savings accounts – all of which may have varying tax implications. With all these assets, accounts and investment vehicles, tax efficient investing can seem like a daunting task, but, at the end of the day, a smart strategy can come down to three words: location, location, location.
Why Consider Your Assets’ Location?
The middle class and even some who are considered affluent are faced with many financial challenges – a tough job market, stagnant wages, lack of savings, and the rising cost of health care (from both higher premiums and higher deductibles). With Federal debt at an all-time high, and state capitals needing to balance their budgets, the middle class and affluent will likely be asked to pay more. Whether it is in the form of higher federal and state income taxes, property taxes, sales taxes or higher fees and use taxes, or the elimination of deductions and loopholes, lawmakers can get creative when they need to raise money. And despite what some politicians say, our current economic climate is showing few signs of a lower tax environment. In fact, some very popular politicians are openly calling for an increase in taxes. More than ever before, today’s middle class needs to be aware of this rising tax burden and take steps to reduce its impact now and in the future.
Asset Location for Tax Efficiency
This may surprise some, but the general concept of asset location is straightforward. You want to place your investments with the highest taxable income in accounts that provide tax advantages such as tax deferral, and conversely, place your more tax-efficient investments inside taxable accounts. For example, municipal bonds and long term stock holdings can be placed in your taxable (brokerage) accounts, and taxable bonds, multi-asset funds, real estate, actively traded mutual funds and any high income fund, might be better placed inside your tax-deferred accounts such as IRAs, 401(k)s, Roth IRA’s etc.
Though the basic concept of asset location is simple to grasp, there are many considerations that make these movements complex. So before making any changes to your asset location, you must consider your time horizon for each investment, the impact any reallocation has on your liquidity, tax implications, transaction costs, and a variety of other factors before making these changes. You also want to make sure you wind up with your desired overall asset allocation. Therefore, it might make sense to get some assistance from a seasoned financial advisor, and for tax matters it’s always a good idea to check in with your CPA. Once you reallocate and benefit from a smart asset location plan, you may get your assets working more tax efficiently, and the blooms on your portfolio should last even longer!
Mark Avallone, MBA, CFP®, CRPS®. www.PotomacWealth.com
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This material represents an assessment of the market environment at a specific point in time and is not intended to be a forecast of future events, or a guarantee of future results. This information should not be relied upon by the reader as research or investment advice regarding any funds or stocks in particular, nor should it be construed as a recommendation to purchase or sell a security. Past performance is no guarantee of future results. Investments will fluctuate and when redeemed may be worth more or less than when originally invested. Diversification and asset allocation do not guarantee against loss. They are methods used to manage risk.
* Opinions expressed are subject to change without notice and are not intended as investment advice or to predict future performance.
*The economic forecasts set forth in the presentation may not develop as predicted and there can be no guarantee that strategies promoted will be successful.
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