Essential Tax Management Strategies for Your Investments

An important part of maximizing your investment returns is how you manage taxes.

“The focus is not so much on what you earn, it’s what you’re able to keep,” emphasizes JT Lavery, Associate of Sales at Symmetry Partners. “A solid tax strategy—one that’s flexible and adaptable to current tax situations—can help.”

A forward-thinking tax planning approach can help you optimize opportunities to lower your tax burden—or at least postpone it as long as possible.

Let’s dive into some strategies your financial advisor can employ on your behalf—often in collaboration with money managers.

Tax-Loss Harvesting

With this strategy, you can capitalize on portfolio losses by selling securities that have declined in value to counterbalance stocks with gains.

Investors with the potential to reap the greatest rewards from tax-loss harvesting typically have:

• significant realized capital gains
• a high share of their overall investment portfolio in taxable accounts
• a long-term buy-and-hold investment strategy for a substantial portion of their assets
  
  

Direct Indexing

One of the appeals of direct indexing solutions, such as Symmetry’s Axiom, is that they allow for greater flexibility around tax loss harvesting. If you own an index fund or ETF for a popular index, such as the S&P 500, your gains or losses are represented by how the index does as a whole. Yet if you owned all 500 stocks directly, some would go up, some would go down, and you could pair these gains and losses to reduce your overall tax burden.

The direct ownership of stocks—which is at the heart of direct indexing—typically enables this kind of approach to tax management.

Asset Location Optimization

This tax-minimization strategy aims to strategically allocate different investment types across taxable and tax-advantaged accounts to reduce the tax burden. An added benefit—it provides permanent and temporary tax savings.

Morningstar provides a summary of the strategy:

• Temporary tax benefit: Hold tax-inefficient investments in the IRA to defer tax until distribution
• Permanent tax benefit: Hold appreciating assets in taxable accounts to defer tax on appreciation, and only pay capital gains tax when sold
• Permanent tax benefit: Hold high-growth investments in Roth IRAs to get the maximum benefit from nontaxable status
  
  

Tax Diversification

Similar to asset location optimization, tax diversification reduces risk by strategically allocating assets throughout numerous investment accounts with differing taxation, such as:

• IRA Accounts

  — provide tax advantages for retirement savings. When you contribute to a traditional IRA, it’s usually tax-deductible, and earnings within the account continue to grow tax-deferred until withdrawal, but withdrawals from traditional IRAs are typically subject to income tax. Conversely, Roth IRAs are funded with after-tax dollars, so contributions aren’t tax-deductible. Qualified withdrawals from a Roth IRA, however, are tax-free.

• 401(k) Plans

  — are employer-sponsored retirement plans. Contributions to traditional 401(k) plans are made with pre-tax dollars, which reduces your taxable income in the year of contribution. Earnings in the account grow tax-deferred until withdrawal when they’re subject to ordinary income tax. In addition, some employers offer Roth 401(k) options, which allow contributions with after-tax dollars, offering tax-free withdrawals in retirement.

• Health Savings Accounts (HSAs)

  – are tax-advantaged accounts used for medical expenses. HSA contributions are tax-deductible or made with pre-tax dollars if they’re contributed through a payroll deduction. Earnings within HSAs grow tax-free. Withdrawals for qualified medical expenses are also tax-free. HSAs offer a triple tax advantage: contributions, earnings, and withdrawals can all be tax-free when they’re used for eligible medical costs.

• 529 College Savings Plans

  – are investment accounts intended for educational expenses. Contributions to 529 plans aren’t federally tax-deductible; however, some states offer tax benefits for contributions made to in-state plans. Earnings in 529 plans grow tax-deferred, and withdrawals are typically tax-free if they’re used for qualified educational expenses.

Minimizing Turnover

Buying and selling holdings within a portfolio can result in substantial taxable capital gains that degrade after-tax returns. With a tax-managed fund, turnover stays low because they invest for the long term without trying to outguess the market.

Focusing on Longer Holding Periods

Selling investments held for less than one year triggers a short-term gain, which is taxed as ordinary income. (For investors in the highest tax bracket, this rate is more than 40%.) Investments that are sold after the one-year holding period are taxed at a lower long-term capital gain rate. (For investors in the highest tax bracket, this rate is nearly 24%.)

Managing Tax Lots

A portfolio’s complete position in a security can include shares purchased on different dates and at different prices. Selling tax lots with a higher cost basis before those with a lower cost basis can defer taxes due on the shares that would generate the highest taxable gains, which may improve after-tax return.

Tax-Efficient Portfolio Management

Some mutual funds and ETFs are specifically designed to be tax efficient. For example, Symmetry’s Mutual Funds and Models emphasize reducing the negative impact of taxes on overall return. In 2022, the Tax-Managed 60% Equity / 40% Bonds model offered a lower tax cost ratio of .65 vs .76 for its peer group, making it 15% more tax efficient.

In addition, Symmetry’s PrecisionCore Tax-Managed ETF Models use a strategy designed to minimize portfolio turnover to help reduce the impact of taxes. PrecisionCore exclusively uses ETFs, which can improve overall tax efficiency, since their structure generally minimizes capital gain distributions.

Planning Ahead

Experienced financial advisors are well-educated about tax-efficient portfolio management and can provide useful information about how best to structure your individual investment tax situation. Your financial advisor should also work closely with your CPA to ensure your entire tax situation is properly factored in.

Interested in learning more about how your taxes can efficiently work for you? Read our blog, Understanding Symmetry Tax Alpha - Helping Maximize After-Tax Results, and download our Tax Alpha Program brochure.