Taxation – Brian Puckett's Blog

How Asset Location Can Help Fatten Your Nest Egg

The U.S. tax code is overly complex, not just for the income you earn working in your career, but also for the income you earn from your investments.

The good news is that by understanding the different tax treatment that applies to different investments—and account types—we can plan a tax-wise asset location strategy. And, successful asset location can significantly minimize the amount of taxes you pay on your investments as a whole. This can lead to a meaningful increase in your after-tax return—the money you get to keep, which is all that really matters.

How to Minimize Taxes in Retirement

If you’re an investor, you’ve surely heard the saying “It’s not what you earn, it’s what you keep.” Minimizing taxes is important when you’re growing your savings for retirement—but it’s at least as important after you’re retired.

That’s why retirees with different types of taxable and tax-deferred accounts should carefully plan the sequence in which they will withdraw money from those accounts. At stake is not just tax savings but also the potential for greater investment growth.

The various account types include traditional IRAs and workplace plans such as 401(k)’s, which are funded with pre-tax dollars. In these vehicles, taxes are deferred until withdrawal so that those assets can compound and grow faster. Roth 401(k)’s and Roth IRAs are funded with after-tax dollars, and their assets grow and are withdrawn tax-free. Finally, many investors have taxable brokerage accounts, which are funded with after-tax dollars and accrue taxes on gains, interest, and dividends.

Let’s look at some of the rules and guidelines when it comes to retirement-account withdrawals. One rock-solid rule is that retirees should prioritize taking their required minimum distributions (RMDs) from their traditional 401(k) or IRA. Failing to do so will trigger penalties—half of the withdrawal that was required—that outweigh any other advantage.

RMDs kick in at age 70 ½. They are calculated based on your life expectancy and the assets in your account. A simple example: A retiree with a 20-year life expectancy and $100,000 in a traditional IRA would be required to withdraw one-twentieth of his assets ($5,000) and pay tax on that amount.

Beyond that, the rules should be considered more flexible based on your individual circumstance and needs. Once RMDs are taken, the standard sequence is to withdraw from taxable accounts, then tax-deferred accounts, then Roths, in order to minimize the tax bite.

In general, taxes are highest on traditional 401(k)’s and IRAs. Withdrawals from these accounts are subject to ordinary income tax, with rates as high as 39.6%. By comparison, long-term gains and qualified dividends in your taxable account are taxed at a lower rate that tops out at 20%.

It’s often best to leave Roth accounts for last. Since they are not subject to RMDs and assets are withdrawn tax-free, it makes sense to let the account balances grow as large as possible.

Withdrawal planning should be flexible from year to year. One reason is that an individual’s tax picture can change based on their expenses, their available deductions and other factors. For instance, large deductions in a given year could drop you into a lower tax bracket. In such a case, it may make sense to withdraw more from a traditional 401(k) or IRA to take advantage of the temporary low tax rate.

On the other hand, retirees should take care to avoid having withdrawals kick them into a higher tax bracket. The bottom line: The taxman doesn’t retire when you do. To minimize taxes and to stretch your retirement income as far as possible, withdrawal planning is a must. Please contact us with any questions you may have.

Brian Puckett | JD, CPA, PFS, CFP®
13921 Quail Pointe Drive | Oklahoma City, OK 73134
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Maximize Your Returns by Minimizing Your Taxes

Everyone loves earning money, including investment gains—but what’s most important is how much you keep after taxes.

And as you know, taxes are becoming a higher hurdle. The top rate is now 39.6%, plus a 3.8% Medicare surtax on investments for high earners. And that doesn’t include state taxes.

Minimizing taxes, then, is essential for those who want to build real wealth. That’s especially true if we experience more moderate market returns over the next few years. Every dollar counts—and that’s true whether you have a taxable investment account or a tax-deferred account. Eventually, Uncle Sam will want his cut.

At Align Wealth Management, we weave tax management into our investing advice and services. We use the following strategies to help ensure that our clients accrue as little in tax liabilities as possible.

Asset location. If you hold taxable and non-taxable investment accounts, you can gain a tax edge by strategically distributing your investments across your respective accounts. A simple example: Since tax-exempt municipal bonds have built-in tax protection, putting them in a tax-deferred account like a traditional IRA would be redundant. It can be wiser to tuck those munis into a taxable account, and use your tax-advantaged account to house investments that would otherwise be exposed to taxes. Asset location is no minor matter: Researchers at Vanguard have determined that it can boost your net returns by up to .75%.
Tax-loss harvesting. Capital gains from your investments are subject to tax. But losses in your portfolio can be used to offset those taxes. Tax-loss harvesting allows us to use realized losses in order to offset taxable gains, and then to reduce ordinary income, up to $3,000 per year. If you harvest losses in excess of $3,000 in a given year, you can use the remaining losses to neutralize gains in future years.
Long-term investing. When an investment is sold for a profit less than a year after it was purchased, investors are faced with short-term capital gains taxes of up to 43.4%, depending on their tax bracket. It’s vastly preferable from a tax standpoint to hold investments for at least a year, because long-term gains are taxed at a rate no higher than 23.8%. Disciplined, long-term investing is a cornerstone value at Align Wealth Management.

Tax management can also continue to have a significant impact once you’re retired. For example, the order in which you take withdrawals from different kinds of accounts—taxable, tax-deferred and tax exempt—can reduce your annual tax liabilities by thousands of dollars. Research, again from Vanguard, has shown that smart withdrawal strategies can add extra net returns of up to .70% a year.

No one can control the market. But controlling the things that we can—like taxes—can have a powerful impact on our long-term wealth. Please don’t hesitate to get in touch if you’d like to learn more about how to boost your effective gains by lowering your taxes.