The Zen of Tax Management, Part 2: Are You as Efficient as Possible?

Zen of tax managementIf you read yesterday’s piece on tax-efficient investing, you know tax-wise investing is a way of life that affects your own best practices as well as the fund managers you choose.

There are two other important areas to tend to as part of your due diligence: your investment portfolio’s tax-efficient management and your advisers’ tax-efficient teamwork.  

The Proper Technique for Managing a Tax-Efficient Portfolio

Beyond tax-wise management of your individual funds, some categories of investments are inherently more tax-efficient than others. For example, stock funds are usually more tax-efficient than bond funds. A plain vanilla U.S. stock fund tends to be more tax-efficient than funds seeking to capture the expected premium returns from smaller, less liquid markets.

This means that another vital way to manage your taxable income is to practice wise asset location.

For those unfamiliar with the concept of asset location, it’s a term that refers to placing the least tax-efficient funds in tax-sheltered retirement accounts, where the inefficiencies are more effectively rendered moot.

The reverse is true for your most tax-efficient holdings. Their tax-efficient advantages are often lost in tax-sheltered accounts.

Why This Isn’t as Easy as It Sounds

The concept is simple enough, but implementation can be tricky.

First, there is only so much room in your tax-sheltered accounts. Challenging trade-offs must be made to ensure you’re making best use of your available tax-sheltered “space.”

Effective asset location also involves considering other tax-planning needs, such as the ability to harvest capital losses against capital gains, donate appreciated shares to charity, implement a step-up in basis, and take foreign tax credits. While these opportunities have more or less importance depending on your goals and circumstances, they become unavailable for stocks held in tax-sheltered accounts.

The Simple Solution (Hint: There’s No “I” in It)

In short, arriving at – and maintaining – the best asset location formula for you and your unique circumstances is something of an art as well as a science.

To handle this, it’s important to have a well-coordinated advisor team. Your team can ensure you’re making the best use of all of the wealth-building opportunities available to you, including, but not limited to, asset location.

Where is Communication Breaking Down in Your Portfolio?

It’s important to manage your investments with a constant eye on tax efficiency. But what about when it comes time to transfer your wealth – bequeathing it to heirs and making meaningful donations? What about your tax filings themselves? Is your accountant aware of what your investment manager is up to, and are both of them informed of pertinent details related to your estate planning?

Are key members of your financial team – your estate planning attorney, investment adviser, tax professional, insurance providers and others – acting independent of each other or as an actual team?

Even if each is seeking to best manage tax-related events within his or her specialized area of expertise, it’s important to identify where communication might be breaking down. If there is little or no coordination among their activities, unnecessary (taxable) gaps or overlaps may occur.

Do You Want Your Net Wealth to Have Power?

Tax-efficient investing can add considerable power to your net wealth – the kind you and your family get to keep after taxes and expenses take their toll. But making the most of the many opportunities can be daunting if you’re going it alone.

At McLean, we can organize the many moving parts and players involved, keep an eye on it, and help you and your team make adjustments when appropriate. Click here to schedule a meeting with one of our advisors to see what we can do for you.


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