Five Things You Can Control: Taxes

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In Don Phillips’ article “The Things You Can Control ” he suggests that the best advisors help their clients focus on what can be controlled and not fret about the the rest even when when uncontrollable things are what clients think are the most important. His fifth suggestion is to:

5. Be tax-savvy. Investors don’t have complete control over taxes, but that doesn’t mean they have none. Assigning assets to taxable or tax-deferred accounts, choosing between municipal- or corporate-bond funds, buying active or passively managed funds – each of these choices can influence portfolios’ tax efficiency. Sadly, the United States is one of the least tax-efficient markets for fund investors, being one of the few markets in the world to force taxable distributions of internally-generated capital gains in mutual funds. Fund taxes are messy, but there are ways to control them. Smart advisors pay attention to potential capital gains exposure. They are wary of events like manager or strategy changes that may unlock gains, and may insist on smaller or even negative exposure in such cases.

A dollar saved on taxes is worth more than an extra dollar of income because the extra dollar of income is in itself taxable. For this reason, advisors who provide tax planning to their clients may bring a much greater benefit than those who only provide investment advice. Unfortunately, most so-called advisors are only commission-based agents who earn their living through hidden fees and commissions. They are in the business of enriching themselves and have finally admitted to courts that they don’t even provide investment advice.

A significant after-tax return can be gained by carefully assigning investments to the right type of investment accounts. We first wrote about this technique in early 2005 in a three part series entitled “Choose the Appropriate Investment Vehicle.” In 2009 we recorded a video explaining the technique. Subsequently, this technique has acquired the appropriate shorthand of “asset location.”

Morningstar suggests that advisors bring an additional 0.52% to their clients using appropriate asset location strategies alone. We believe that 0.50% is a conservative number and that it is earned the very first year. Recently we wrote the article, “Asset Location Can Significantly Boost After-Tax Returns“, which shows that the value of this technique is compounded over multiple years. Because of that, we believe that the benefit is as high as 0.76%.

In addition to assigning investments to the right investment vehicles, a Roth conversion or segregation also reaps large tax savings as you shift assets to accounts with superior tax savings potential.

Further, the great complexity of current capital gains legislation provides many opportunities for saving. We have written about “Fourteen Ways to Avoid Paying Capital Gains” to which must be added finding the moments in which you want to strategically intentionally realize capital gains.

Find a fee-only fiduciary and ask them about tax planning. You deserve an advisor who understands the big picture.

Photo used here under Unsplash Creative Commons Zero.

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President, CFP®, AIF®, AAMS®

David John Marotta is the Founder and President of Marotta Wealth Management. He played for the State Department chess team at age 11, graduated from Stanford, taught Computer and Information Science, and still loves math and strategy games. In addition to his financial writing, David is a co-author of The Haunting of Bob Cratchit.