Tax-Smart Investing: How to Keep More of What Your Investments Earn

Most investors focus on returns, fees and risk, but taxes can have just as big an effect on how much wealth you build. Two people who own the same investments can end up with very different results depending on which accounts they use, when they sell and how they draw money out in retirement.

The good news is that tax-smart investing does not require complicated strategies. A handful of steady habits, used consistently, can help more of your money stay invested and keep compounding.

Use the right accounts in the right order

Start with workplace retirement plans such as a 401(k) or 403(b), at least up to any employer match. Traditional contributions can lower your taxable income today, while Roth contributions are made with after-tax dollars and can grow tax-free for qualified withdrawals later. Many people benefit from having both, which gives them flexibility in retirement.

If you have a high-deductible health plan, a health savings account can be especially powerful. Contributions may be deductible, growth is tax-deferred and withdrawals for qualified medical expenses are tax-free. IRAs and Roth IRAs add even more room to save with tax advantages.

It is not what you earn that builds wealth. It is what you keep.

Place, hold and sell investments wisely

Asset location means holding each investment in the type of account where it is taxed most efficiently. Investments that produce a lot of taxable income often fit well in tax-advantaged accounts, while broad, low-turnover stock funds can be efficient in a taxable account. Holding investments for more than a year before selling generally qualifies gains for lower long-term capital gains rates.

In taxable accounts, tax-loss harvesting can help. Selling an investment at a loss and replacing it with a similar, but not substantially identical, one can offset gains and up to a limited amount of ordinary income each year. Unused losses can carry forward to future years.

Finally, plan withdrawals before retirement begins. Deciding which accounts to draw from first, and whether to make Roth conversions in lower-income years, can reduce taxes over decades. Colorado has a flat state income tax, so federal planning often makes the biggest difference.

The advisors at Tax Wealth Path help investors in Fort Collins and across Northern Colorado build tax-smart portfolios. Contact us for a free tax and wealth review.