Another April is nearly behind us, and millions of Americans have wrapped up the often frustrating process of filing their taxes. It’s not something many people enjoy, but it’s also not something you can just avoid (not without risking a prison sentence, anyway).
Your tax season can get easier if you utilize tax optimization in your investments, which can save you money and potentially create stronger growth in your assets. Here’s how Grey Ledge Advisors works with our clients, and with certified public accountants (CPAs), to pursue this goal.
Who can benefit from tax optimized investments?
Anyone can benefit from a wise structuring of their investments. However, these advantages are especially useful for higher income earners since they face higher marginal tax rates on their income, have a broader and more complex range of assets and investments, and enjoy greater flexibility in how they can strategically allocate their investments.
While there is no set definition for how much money one must earn to receive the strongest benefits from tax optimization, it is often recommended for those earning over $200,000 a year. It is also a useful option for people with liquid assets of $1 million or more, which is the standard definition of a High Net Worth Individual.
The key benefits of tax optimization while investing include:
- Substantial savings: Even small percentages of tax savings on large investment portfolios can translate to a considerable sum.
- Avoiding higher tax brackets: Strategic investments can help high-income individuals being pushed further into higher tax brackets, both during their working years and in retirement.
- Preserving wealth for future generations: Estate tax planning, a critical component of tax optimization for the wealthy, aims to minimize the transfer taxes on assets passed down to heirs, preserving more of their wealth.
Tax optimization strategies
Tax optimization strategies focus on taxable income, capital gains, and the estate tax. Income tax optimization focuses on strategically organizing your investments to reduce your taxable income, including:
- Maximizing contributions to tax-advantaged retirement accounts such as 401(k)s and IRAs, as well as Health Savings Accounts
- Utilizing deferred compensation plans that allow you to push income tax liability to a later date, when an individual is potentially in a lower tax bracket
- Optimizing businesses for the most tax-efficient legal structure
- Pursuing tax-exempt investments such as municipal bonds
- Charitable giving strategies like donor-advised funds, qualified charitable distributions, and charitable remainder trusts
Capital gains taxes apply to profits made from the sale of certain capital assets, including stocks and bonds. A financial advisor can help you improve the efficiency of your investments as they relate to capital gains by:
- Tax-loss harvesting, or selling unprofitable investments to offset capital gains from successful investments
- Investing in long-term assets to receive lower capital gains tax rates
- Using tax-efficient investments like exchange-traded funds (ETFs)
- Direct indexing to allow for personalized tax management, including more sophisticated tax-loss harvesting at the individual security level
- Gifting assets that have appreciated in value to charity
Finally, tax optimization allows a high-income individual to minimize estate taxes, which are applied during the transfer of assets to one’s beneficiaries after death. Financial advisors employ strategies that include:
- Using annual gift tax exclusions to reduce the size of the taxable estate over time
- Contributing to 529 plans to support the tax-free growth of funds that can be used to pay for the qualified education expenses of beneficiaries
- Establishing trusts to remove assets from the taxable estate, manage asset distribution, and provide for beneficiaries
- Organizing bequests for qualified charities
The role of a financial advisor in tax optimization
A knowledgeable financial advisor will offer important advice and guidance on the strategic implementation of tax-efficient investment options to ensure that you’re seeing the greatest benefit. They will also use investment strategies to ensure that assets are strategically allocated to the most tax-advantaged accounts. For example, this might include using high-growth stocks in a Roth IRA to enable potentially strong gains to occur tax-free.
A financial advisor will understand the tax implications of investment decisions like buying, selling, rebalancing assets; actively monitor portfolios for opportunities to use tax-loss harvesting or other options; and integrate goals like charitable giving or estate planning into a client’s portfolio management.
Financial advisors also work closely with CPAs to provide the following benefits:
- Sharing detailed information and holding joint planning meetings about the client’s investment holdings, transactions, and overall investment strategy
- Proactively identifying tax issues related to investments
- Coordinating strategies on tax-loss harvesting, charitable giving, estate planning, and more
To learn more about tax optimization options, set up a meeting with Grey Ledge Advisors by using our online contact form or calling 203-453-9075.