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Of all the expenses investors pay, taxes have the potential to take the biggest bite out of their total returns. That's why it pays to be sensitive to taxes as you build and manage your investment portfolio.
We are all familiar with advantages of using tax advantaged retirement savings accounts (such as 401ks, 403bs, IRAs, & Roth IRAs), however, what can be done if an investor has a portfolio consisting of both tax-advantaged and taxable accounts? Too often we see duplication within these various accounts instead of a more tax smart approach.
Take, for example, a hypothetical couple named Jack and Jill Hill. Jack has a $200,000 balance in his 401k account, Jill has a Rollover IRA valued at $300,000 and they jointly own a taxable investment account worth $500,000. The investment objectives for the Hills call for a moderate allocation of 50% stocks and 50% bonds. Conventional wisdom would suggest that each of these accounts should be allocated to the 50/50 target and we could call it good. However, not all investment tax is the same. Earnings on particular asset classes such as bonds are taxed at a higher rate than the qualified dividends and long-term capital gains that stocks tend to generate.
Rather than duplicating the same asset allocation within each account, Jack and Jill would be better served to LOCATE assets within their total portfolio to maximize tax efficiency. In this case, the 401k and IRA could be used to hold the bond exposure (50% of the total portfolio) and the joint account could be used to hold the stock exposure. This subtle shift maintains the integrity of the overall asset allocation target (50/50) but will also drastically reduces the total tax that the Hills will pay on their investment portfolio.
Intrigued? Give us a call, we'd be happy to explain more...
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