September 26

Five Simple Ideas for Tax Efficient Investing


Published Shoreline Financial Articles

By GA​RDNER SHERRILL |Investor’s Column

September 27, 2016

Five Simple Ideas for Tax​ Efficient Investing

I’ve written fairly extensively over the past year about investing in expensive markets. If you believe, as I do, that the next five years may produce lower returns, then managing frictional costs becomes even more important. As we move quickly towards the year end of 2016 I thought I’d focus my efforts today on some strategies you can employ to increase the tax efficiency in your portfolio.

Asset Location

Where your assets are located (within taxable or tax deferred accounts) can be an important decision. The basic idea is that those assets that are tax inefficient (they create taxable income or short term capital gains) should be placed in tax deferred accounts like IRA’s, and those assets that are more tax efficient (qualified dividend income, growth stocks) should be placed in non-qualified / taxable accounts. By constructing your portfolios in such a fashion you are able to avoid recognition of the more unfavorable tax treatment by sheltering and deferring those gains until taking a distribution from the qualified accounts. Blanchett and Kaplan in their paper Alpha, Beta, and now Gamma argue the benefit to a retiree could be as large as half a percent per year.

Some asset location decisions may not be as intuitive as we would hope them to be. Most international stocks and even ADR’s (American Depository Receipts) levy withholding taxes on dividends paid to US investors. In a taxable account these withholding taxes can be offset by the foreign dividend tax credit. A tax deferred account can’t benefit from the dividend tax credit and therefore international securities are best held in taxable accounts. There are a few exclusions such as the United Kingdom and India which do not levy withholding taxes and therefore could be held in either type of account.

Prioritization of the asset location decision largely rests on personal goals and objectives. Tax decisions shouldn’t necessary drive investment decisions. For example, fixed income or bonds are often associated with interest income which is taxed at ordinary rates. As such they are often considered best placed in a qualified account or IRA to shelter the income. In today’s low yield environment it might be more impactful to place a higher growth vehicle into the IRA to provide greater long term benefits. By modeling out various goals and scenarios you can better make more informed decisions that hopefully can lead to better outcomes.

Tax Loss Harvesting

Tax loss harvesting is a popular tax planning strategy, especially as the investors scramble at year end to accelerate deductions into the current year and postpone income recognition to the following year. The basics idea is that you find a position in your non-qualified accounts that carries a loss. You sell the position to capture the loss to use against taxable income for the year. You must stay out of the positon for a full 30 days before repurchasing or the IRS will disallow the deduction. Google search “IRS Wash Sale Rules” for the rules.

3.8% Medicare Surtax

I wrote more extensively to this in the Bradenton Herald business section on October 29th, 2013. If your modified adjusted gross income exceeds $200,000 individually or $250,000 jointly, you should consider having a strategy in place to minimize your recognition of unearned income.

Charitable Contributions

Charitable contributions allow an immediate deduction up to annual limitations. In order to maximize your tax advantages consider utilizing appreciated securities or even required minimum distributions from your IRA if you are over 70 1/2. Both will provide you a better deduction and the charity can use their 501c3 status to avoid the gains on their end.

Deduction of advisory fees

I often see tax returns from new clients that don’t take a deduction for advisory fees. Expenses for investment advisory services are includible as a miscellaneous deduction subject to the 2% limit. You cannot deduct advisory fees charged to an IRA or qualified account. Talk to your tax advisor about whether it makes sense to pay qualified advisory account fees from an outside account.

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Gardner Sherrill, CFP, MBA, is an independent financial advisor with Sherrill Wealth Management. To learn more visit sherrillwealth.com. This information is not intended to be a substitute for specific individualized tax advice. We suggest that you discuss your specific tax issues with a qualified tax advisor. The opinions expressed in this material are not intended to provide specific advice or recommendations for any individual. Asset allocation does not ensure a profit or protect against loss.

Securities and advisory services offered through LPL Financial a registered investment advisor. Member FINRA/SIPC.



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About the author

Gardner is a CERTIFIED FINANCIAL PLANNER and principal of Sherrill Wealth Management in Bradenton, Florida. He has spent 20+ years in the wealth management field helping families negotiate the various obstacles and opportunities that retirement provides them. Read More

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