Tax planning may not be the most exciting part of creating a financial plan. But if you want to keep more of your money in your pocket, active tax management is critical.
For instance, let’s say you’re planning on selling your business. While negotiating a good price is important, so is structuring a tax-efficient way to receive the proceeds. Investing these assets strategically post-sale can, in turn, help minimize taxes as you draw down the funds over the years.
At SWP, we believe that active tax management should play a central role in any financial plan. In this article, we’ll outline the key strategies involved in implementing appropriate and effective tax management.
Choosing the Right Tax Resources
For many people, tax management is something to think about once a year in April. But by assembling the right resources, you can ensure tax planning is integrated into your wealth strategy on an ongoing basis.
Given the depth of the topic, we believe that working with a team of professionals is the best way to effectively manage potential tax liabilities. At the core of that team should be a trusted CPA who can advise you on all tax-related matters.
Meanwhile, your wealth advisor should coordinate with your CPA to ensure your taxes are considered holistically – including both income and investments. A wealth manager can leverage best-in-class financial planning software to gain even more insight into your tax plan. Examples of software include, but are not limited to Holistiplan, for reviewing old tax returns and identifying strategies for tax bracket management, and eMoney, for tax-efficient cash flow planning. While the software is no replacement for a team of real advisors, these advanced planning tools can help uncover opportunities for improving your tax situation that might otherwise be overlooked.
In fact, one area where tax opportunities are often overlooked is your investment portfolio.
Portfolio Strategies to Effectively Manage Taxes
When it comes to evaluating investment results, annualized pre-tax returns are just one part of the performance equation. While these returns tend to be the headline figures, taxes can play a significant role in determining realized (or “take-home”) investment performance. Therefore, portfolio construction should take place with tax optimization in mind.
For example, the type of investment vehicles you choose will impact your overall tax picture. When choosing between similar ETFs and mutual funds, you may want to opt for ETFs. These vehicles tend to be more tax efficient as they may not be subject to capital gains distributions.
Direct indexing, which involves replicating an index with individual positions in an investment account, can also be a beneficial allocation decision. Direct indexing allows you to harvest losses on individual securities. These realized losses are, in turn, passed through to you and your tax return.
But investment allocation isn’t the only factor. Investment location, referring to the type of account into which each investment is placed, matters too. For instance, investments that distribute substantial amounts of ordinary income may be best kept in tax-deferred accounts. Tax-efficient investments, like the ETFs described above, can populate regular taxable accounts.
Using these taxable accounts effectively can be another tool in your tax strategy. In taxable accounts, you can take advantage of tax-loss harvesting, which involves selling a losing position to realize a loss. This loss can offset other income for the year, up to a limit. You can avoid materially affecting portfolio allocation with these sales by purchasing similar (but not identical) positions.
Charitable Giving: Doing Well by Doing Good
Just like your investment strategy, your philanthropic strategy should be developed with taxes in mind. At SWP, we believe in the importance of giving back – but we also believe in the importance of doing it with tax efficiency in mind.
If you’ve had a high-income year, for instance, you can time your charitable giving to match. If you were already planning on giving, this is an excellent opportunity to lower your tax burden. While giving directly is an option, there are other strategies available that preserve some flexibility.
A donor-advised fund (DAF), for example, is a way to take an immediate tax deduction on your charitable giving while retaining flexibility over where the funds will ultimately go. By contributing to a DAF, you can deduct the full amount of your gift today, but the money is held in the fund until you’re ready to disburse it to charity. This structure could be a good option if you know you want to give to charity but can’t decide on an organization right now.
Charitable giving can also help fully utilize the value of highly appreciated assets. If you sell an asset and gift the cash proceeds, you’d have to pay taxes on the gain from the sale. But, by donating the asset to a charitable cause without selling, you incur no capital gains taxes while still receiving the income tax deduction. This strategy also helps you maximize your donation size since you don’t have to give up a portion of the asset’s value in capital gains taxes first.
Closing Thoughts
As outlined in this article, active tax management is a crucial part of your wealth strategy. A thoughtful team of professionals can help structure your finances appropriately, keeping more money in your pocket and helping you use your resources as efficiently as possible.
At SWP, we aim to be a key player on our clients’ tax team. With our background and experience in optimizing investment taxes, we coordinate with our clients’ CPAs and other advisors to help create a holistic tax plan.
If you’d like to discuss how your investment plan can be used as a tool to improve your tax situation, we invite you to reach out to our team today.
The information herein was obtained from third party resources that SWP deems to be reliable as of the original date of publication. SWP does not have affiliation with Holistiplan or eMoney.
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