Tax-efficient investing is about finding the right balance between minimizing current taxes and future tax liabilities. Here's our plan:
- Use proper asset location. A portfolio designed using an overall allocation for multiple accounts allows for better tax-efficiency. Pre-retirement portfolios usually place high growth assets in Roth IRAs, tax-efficient growth assets in taxable accounts, and tax-inefficient assets in tax-deferred accounts. Retirement portfolios will vary due to the withdrawal needs, assets, and tax situation of each person.
- Don't just max out your 401(k) or 403(b). Having only tax-deferred accounts in retirement could present a tax nightmare. Forgoing an immediate tax deduction (Roth IRAs, taxable accounts) provides for better tax flexibility in the future.
- Use a buy-and-hold approach. Frequent trading in a taxable account could result in more taxes. The more taxes you generate, the lower your after-tax return. Only trade when necessary.
- Buy investments with low turnover. The investments you buy should also practice a buy-and-hold approach. Active trading within a fund usually leads to lower return and higher taxable distributions (if held in a taxable account).
- Sell smart. Make sure sales in a taxable account are long-term gains. When rebalancing, try to make trades in tax-deferred or tax-free accounts to avoid taxable gains.
- Review taxable accounts for losses throughout the year. Tax-loss harvesting is not just a December activity. Tax losses should be taken whenever they are available, even if no gains exist yet.