Minimizing Retirement Taxes using Tax-Loss Harvesting and Asset Placement
Discover the powerful strategies of tax loss harvesting and asset placement to optimize your investment portfolio and reduce your tax burden. Whether you're looking to fine-tune your portfolio or simply enhance your tax planning strategy, this video will provide you with actionable insights to help you make smarter financial decisions.
Today I’m going to discuss two key strategies to help you manage your retirement taxes more effectively:
(1) Tax-Loss Harvesting, which you’ve probably heard of if you’ve done much research on this topic - and it can get a lot of hype, but I believe that sometimes people selling it are confusing motion for progress, and I’ll explain that more in just a bit.
(2) Asset Placement: this one might you might not have heard of (unless you have been listening to me for a while), but it can also help mitigate tax drag over your lifetime.
If you want to make the most of your retirement savings while minimizing your tax burden, these two strategies can help you get started.
Tax Loss Harvesting
Let’s start with Tax-Loss Harvesting. This strategy can be particularly beneficial for retirees who can manage their taxable income. Here’s how it works: Tax-Loss Harvesting involves selling investments that have declined in value to realize a loss. This loss can then be used to offset any capital gains you might have realized from selling other investments for a gain.
For instance, let's say you’ve had a good year with some stock investments, but maybe some other investments have lost value. Selling those underperforming investments can help reduce your overall taxable income.
For example: Imagine you sold some stock for a gain of $100,000. Then you sold some other investments at a loss of $40,000 in the same year. Now you can use that loss to offset the gain, potentially reducing your taxable income by $40,000. This can help lower your tax bill for the year, which is especially useful in retirement when managing income is crucial.
Tax loss harvesting is not something that we try to really promote a lot - like some robo firms out there, because again, you've lost some money. Nobody likes that, but it happens, and when it happens, we take advantage of that tax-wise. But it might be more of a band-aid when what you actually need is a cast.
But if selling some investments at a loss can drop you from the 32% ordinary income tax bracket into the 24% ordinary income tax bracket or from the 15% capital gains tax bracket into the zero % tax bracket, it could certainly be beneficial. Especially if your taxable income moving forward might not be as high.
Asset Placement
Now, onto Asset Placement, which is all about where you hold different types of investments to optimize and minimize your lifetime tax liabilities. Note: Asset Placement and Asset Location are the same thing. I use both interchangeably.
Now, you’ve probably heard of asset allocation, but asset allocation is not the same as asset location. Asset allocation is the distinction of the type of investments you own. For instance, you may have heard of a 60/40 or a 70/30 portfolio, and this refers to having 60% equities (or stock) to 40% fixed income or bond-type investments.
But asset placement involves laying our tax code on top of your nest egg by strategically positioning your investments in the 3 different account types we have:
- Taxable accounts
- Tax-deferred accounts
- Tax-free or Roth accounts.
The goal is to minimize taxes over the long term. So, for retirees, this means thinking carefully about where to place your investments to minimize your lifetime tax bill.
Tax-deferred Accounts
For example, we want to place investments that generate regular interest or dividends, which are often taxed at a higher rate (unless they are qualified dividends), into tax-deferred accounts - like IRAs or 401(k)s. These types of investments are our ‘steady,’ lower-volatility investments, our ballast-like investments, and they are more stable but typically slower growing than our equity or growth-oriented investments.
We want these in our tax-deferred accounts because they are going to be taxed at our 7-bracket ordinary income tax rates when we withdraw the money, which is the highest rates in our code.
Tax-free or Roth accounts
If we’re going to have ABC stock go from 10 to 100 over time, we don’t want to pay the highest rates, do we? No, we would rather have ABC stock in our tax-free or Roth accounts because if those accounts are qualified, and we have an investment (like ABC stock) go from 10 to 100, we’re not going to be taxed at all on all of that gain.
Now that’s obviously much better than paying 22, 24, or 32%, or whatever your ordinary income tax rates are, right?
Taxable Accounts
Our taxable brokerage accounts can receive the lower, 3-bracket long-term capital gains and qualified dividend rates. This isn’t as good as paying zero tax, like in a Roth account, but it is still much better than paying ordinary income taxes on our tax-deferred accounts.
So, the idea is to let your investments grow in the most tax-efficient manner possible, by placing higher-yielding, lower growth-oriented investments in tax-deferred accounts, and long-term growth investments in tax-free Roth accounts and maybe our more moderate investments in taxable accounts.
This will potentially reduce your overall tax liability and enhance your retirement savings.
Vanguard’s research states that this strategy can add as much as 0.6% per year to a nest egg if it is implemented properly. This can add up to real solid savings over time.
Bottom line:
These are just two strategies we use to reduce retirement taxes effectively. We use tax-loss harvesting to offset gains and reduce taxable income, and we use asset location by strategically placing your investments across different types of accounts, so we can lower lifetime tax liabilities.
We want to use these strategies to help you keep more of your retirement savings and ensure we aren't paying Uncle Sam one more cent than we owe him.
A CERTIFIED financial planner™ professional can help you plan for your retirement. Schedule a call today so we can talk about your situation.