Financial Planning
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How to Increase the Tax Efficiency of Your Income Portfolio
The income you get from your assets may be impacted by taxes. Building an income stream with better tax treatment can be achievable with careful planning. When investing in bonds, dividends, and managed accounts, you can use these six strategies to increase the tax efficiency of your portfolio.
1. Municipal bonds
Interest income from municipal bonds is typically tax-free at the federal level. Interest may also be excluded from state and local income taxes if you live in the state where the bond is issued. Their tax classification can help offset yields that may be lower than those of taxable bonds.
Municipal bonds can be bought through separately managed accounts, bond funds, individual bonds, or exchange-traded funds (ETFs).
2. Treasurys of the United States
While interest from U.S. Treasury securities is still subject to federal income tax, it is not liable to state or local income taxes. This tax treatment can help investors in states with higher taxes make their portfolios more efficient. Additionally, these securities are considered highly liquid.
Treasurys are offered on the secondary market as well as during U.S. government auctions.
Treasury Interest Maturity Type
- Treasury bills mature at 4, 8, 13, 17, 26, or 52 weeks.
- Treasury notes issued by the US pay semi-annual interest and mature in two, three, five, seven, or ten years
- Treasury bonds issued by the US pay semi-annual interest and have maturities of 20 or 30 years
- Treasury Inflation-Protected Principal Securities (TIPS) adjust principal for inflation and mature in five, ten, or thirty years
- FRNs, or floating rate notes, are interest resets using the Treasury bill auction rates and tend to mature in two years
3. CDs and bonds that are subject to taxes in tax-advantaged accounts
Taxes on interest income can be postponed until withdrawals are made by holding taxable bonds and certificates of deposit (CDs) in tax-advantaged accounts, such as traditional IRAs. Qualified distributions from a Roth IRA may be tax-free. This facilitates more effective compounding within the account and lowers annual interest taxes.
Certain index funds and other tax-efficient assets might be more appropriate for taxable accounts.
4. Accounts that are independently managed (SMAs)
Tax-efficient techniques, such as tax-loss harvesting, can be used on accounts that are independently managed. To counterbalance realized gains, this entails selling investments that have incurred losses. Each year, ordinary income may be offset by up to $3,000 in net capital losses ($1,500 if married filing separately), with any unused losses being carried forward to subsequent years.
SMAs can offer control over the timing of taxable events as well as transparency.
5. Dividends that qualify
Long-term capital gains tax rates, which are lower than regular income rates, apply to qualified dividends. Dividends must be paid by a U.S. corporation or a qualified foreign corporation and satisfy IRS holding-period rules in order to qualify. Dividends that don't comply with IRS regulations, for example, are taxed as regular income.
Qualified dividend tax treatment can increase the after-tax income of a taxable account for qualified shares.
Among the qualifying dividend requirements are:
Holding periods:
Common stock: During the 121-day period starting 60 days prior to the ex-dividend date, owned for more than 60 days
Favorite stock: During the 181-day period starting 90 days prior to the ex-dividend date, owned for more than 90 days
Eligibility of the issuer:
Companies in the United States or eligible overseas firms
Taxes:
0%, 15%, or 20% based on income, with the 3.8% Net Investment Income Tax potentially applied.
6. Annuities that are tax-deferred
Investment profits can grow tax-deferred until they are withdrawn or annuitized, at which point they are subject to regular income tax. This is possible with tax-deferred annuities. Investors who have already made the maximum contribution to tax-advantaged retirement plans could find this helpful.
Depending on income demands, a tax-deferred variable annuity may be accessed through withdrawals or changed to an income annuity.
The bottom line
Over time, more efficient investment income can be supported by aligning your plan with tax-aware procedures. After-tax outcomes can be significantly impacted by managing account placement, selecting tax-efficient investment options, and utilizing tools like annuities and SMAs.
Do you need help?
You can learn which tax-efficient income strategies fit your retirement objectives with the assistance of the Retirement Group. Give us a call at (800) 900-5867 to receive advice tailored to your specific circumstances.