How We Save Your Tax Dollars

Tax Efficiency 101 – How We Save Your Tax Dollars

One of the things that we pride ourselves on is our work with clients on tax efficiency. What do we mean by that? Globally speaking, something is “tax-efficient” if it is taxed at a lower rate than an alternative. Basically, tax efficiency refers to doing something to help reduce your tax burden. Remember that it is not just how much money you make that matters, but how much you keep after taxes.

There is no one size fits all approach to tax efficiency. Like with most things, we consider your goals and entire financial situation to determine the best way to exercise tax efficiency on your behalf.

This can take the form of choosing an investment that will not be as taxable as another:

• A municipal bond fund that is exempt from federal tax is more tax-efficient than taxable bond funds. Both funds pay dividends, but one is non-taxable to you and the other isn’t.
• Tax-efficient exchange-traded funds try to help reduce taxes by maximizing the long-term appreciation on the investment rather than paying out dividends, which will be taxed.

Or it can take the form of choosing which account type to invest your money in:

• Contributing money to an IRA and receiving a tax deduction for the contribution is more tax-efficient than investing money in a taxable brokerage account with no tax deduction.
• Contributing to a 529 college savings plan for your children’s education reduces your tax liability over contributions to a UTMA account.

Or it can take the form of choosing when to sell an investment:

• Selling securities at a loss to offset other securities sold at a gain, creates tax-efficiency by allowing the two items to neutralize each other and have no taxable gain. This is known as tax harvesting. For example, last year we had a client for whom we were able to “harvest” ~$50,000 – offsetting their gains with losses. This resulted in ~$7,500 actual savings on their 2022 tax bill.
• Holding a security for more than one year before selling it creates a capital gain, rather than an ordinary income gain, which is taxed at a higher rate.

And finally, it can take the form of choosing how to structure your charitable donations:

• You may not itemize deductions on your tax return, but if you take the standard deduction, you do not get credit for a charitable contribution. That said, if you take a Required Minimum Distribution (RMD), you can make a qualified charitable distribution from your IRA and reduce your taxable income.
• You can also donate appreciated stock instead of cash so that you don’t have to pay the capital gains tax on selling the stock.

Note that it is not necessarily the tax that becomes more efficient, but rather, the way that you structure an investment to create the best possible tax effect. We focus on tax diversification, meaning, spreading your investments across accounts with different tax treatments to save your money not just in the short-term, but also in the mid-to long-term.

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