Do You Need Investment Tax Diversification?

Don't put all your "tax" eggs in one basket!

Many of us know that it is important to properly diversify our investments (aka “Don’t put all your eggs in one basket”), but how about diversifying across tax types?  If you’re like many Americans, you’re probably saving/investing for several different goals (retirement and college perhaps?).  Since you’re hoping to make that money work as best as possible for your goals, you should make sure your portfolio is not only diversified by types of investments, but by tax types as well.  If you’re not sure what I mean, keep reading – you’ll see where I’m going with this idea of investment tax diversification!

·       Use the following THREE (3) types of accounts/buckets to control how & when to pay taxes:

1.      Pre-tax bucket (e.g., 401(k), 403(b), traditional IRA)

2.      Tax-free bucket (e.g., Roth IRA, HSA, life insurance)

3.      Taxable bucket (e.g., brokerage accounts)

·        There are multiple strategies you can use to implement tax diversification; here’s several of the most important & most used options:

o   Maximize Tax-Advantaged Accounts: contribute to 401(k)s, IRAs (traditional and/or Roth types), & HSAs as much as you can so you take advantage of tax deductions and/or tax-free growth

o   One Large Investment/Position Management: if you own way too much of any one stock, you can do any of the following:

                       i.     Make a charitable gift if your single stock has appreciated a lot in value

                      ii.     Systematic diversification – sell certain $ amounts of the investment gradually over time to reduce risk & limit capital gains taxes

                     iii.     Exchange funds (aka swap funds) – these are pooled private investments that are usually for accredited investors with high minimums

o   Tax-Loss Harvesting: sell investments with losses in taxable accounts to help offset gains from other investments sold in the same tax year

o   Roth Conversions: convert some of your traditional IRA $ to Roth IRA $ when your yearly income is lower (pay the taxes now at lower rates) so you can enjoy a pot of tax- free income later in retirement

o   Strategic Asset Location: you may have heard of strategic asset ALLOCATION, but LOCATION means where to put types of investments in the most optimal types of accounts for the best tax treatment (e.g., high-yield bond funds in traditional IRAs & high-growth funds/riskier stocks in Roth IRAs)

If you need help implementing these various tax diversification strategies for your portfolio (if you are doing it already – congrats!), find a fiduciary who fully understands & already uses these methodologies for clients.  If you didn’t know some/any of these tax strategies before and this article has helped get/keep your portfolio on a more tax-friendly track, then…you’re welcome!

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Find an experienced tax professional who advises clients on investment tax diversification, believes in helping his/her clients improve their personal/tax/financial situations, and has the heart & demeanor of a teacher, NOT a salesman, and chances are you’ve found the right tax professional to help you reach your goals.

For more information, please email marty@mftax.com (PA), matt@mftax.com (FL), or call (570) 760-6524 (PA) or (561) 329-1296 (FL).