How to Invest Tax-Efficiently

You may have heard of diversifying assets, but have you heard of tax diversification of your investments? Whether your goal for investing is saving for retirement, asset distribution, or simply turning a profit, everyone is looking toward a return. However, your return is only as good as the tax cost that comes with it, which is where investing tax-efficiently comes in.

There are two ways in which you can lose to taxes when investing: when the money is taxed upon withdrawal and when you lose the growth potential of investments taxed prior to withdrawal. This brings us to the two types of investment accounts that address each of these: taxable and tax-advantaged investment accounts. While tax-advantaged may sound more immediately appealing, there are different advantages of each account. 

Taxable Accounts
The main advantage of taxable accounts for optimizing tax efficiency is realized in long-term investments. Because the investment funds are taxed prior to investing, you pay fewer taxes on capital gains over a longer period of time. They also offer tax advantages for your heirs, taxed at the value on the day you die, rather than their value at the date of sale. Additionally, you can use tax losses to reduce your taxable income for the year, called tax-loss harvesting. 

Tax-Advantaged Accounts
With tax-advantaged accounts like an IRA or 401(K), the main advantage is that they have tax-free or tax-deferred growth, so you don’t lose the growth potential of the money to taxes. 

Ultimately, to invest tax-efficiently, it’s essential not just to consider the ROI but the tax efficiency of both the investment itself and the account you hold it in. As a general rule, compensating for less tax-efficient investments by putting them in tax-advantaged accounts and putting more tax-efficient investments in taxable accounts is the best way to optimize your investments. 

However, it takes careful consideration of taxes incurred on investment income, capital gains, and dividends, the anticipated length of investment, and even your anticipated income bracket when you withdraw the funds, among other factors. If you’re feeling overwhelmed with how to optimize your investments, contact us to talk with one of our certified financial planners and let us be your trusted advisor in securing your future.

A diversified portfolio does not assure a profit or protect against loss in a declining market. 

For a comprehensive review of your personal situation, always consult with a tax or legal advisor. Neither Cetera Financial Specialists LLC nor any of its representatives may give legal or tax advice.

Distributions from traditional IRAs and employer sponsored retirement plans are taxed as ordinary income and, if taken prior to reaching age 59½, may be subject to an additional 10% IRS tax penalty.

-Written by Nick Deering, MBA, CFP®, CVA®, CLTC | Manager


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