Tax Efficient Investing: Tax Strategies to Save You Money - The Sista Fund (2024)

• Put most tax-efficient stocks and bonds in your taxable brokerage accounts
• Put least efficient stocks/bonds in your tax-advantaged accounts
• Hold stocks for longer than 1 year
• Consider donating stocks with huge gains to charity
• Pass your taxable accounts on to your children

Never knew there was a way to invest your money to save you on taxes, eh? Well, me neither until just a few years ago.

Tax efficient investing is the act of investing in such a way as to minimize your taxes while maximizing your gains. This is done by placing the right investments in theright investment accounts.

There are 3 BIG reason why everyone should be using tax efficient investing strategies.

• It saves you money
• You build your wealth much faster
• It saves your heirs money

By investing your money efficiently you will naturally save yourself loads in taxes. For instance, by holding onto your stocks for longer than a year, you can decrease your Capital Gains Tax significantly.

This is because stocks sold in the short term are subject to your ordinary income tax rate while those held longer than a year are taxed at much lower rates. (See tables below).

Another plus of tax efficient investing is that when it comes time to hand off your wealth to your children you would be able to do so with minimal burden to them.

For example, when you invest in a Roth IRA (a tax free account because the money invested is already taxed), you can pass that on to your children and they won't have to pay taxes on it.

Furthermore, any asset you pass on to your child whether that be stocks/bonds or real estate is "stepped up" when it is given to your kids.

This means that the gains that occurred while you held it is reset so that your children would inherit it at the current market value. And should they choose to sell it immediately, they wouldn't incur any capital gains tax.

When it comes to tax efficient investing, there are two investment accounts that are tax advantaged. This means that these accounts provide you some tax benefits as opposed to a regular taxable brokerage account.

These tax advantaged accounts come in two forms: tax-deferred and tax-free.

These investment accounts provide you with the opportunity to save on taxes now. Meaning you won't pay taxes on the amount you contribute to tax-deferred investment accounts.

Your money is allowed to growtax free and only when you withdraw from the account will you be taxed on the money that you withdraw.

Examples of tax-deferred investment accounts include the 401k, traditional IRA (individual retirement account), and for Canadians the RRSP (registered retirement savings plan).

Tax-deferred investment accounts are great to use when you want to lower your taxable income and pay less in taxes now.

These investment accounts allow you to withdraw your money at a later date completely tax free. Essentially you pay taxes now so that you don't have to pay them later.

So although the money put into these accounts have already been taxed, that money is allowed to grow tax free and withdrawals are completely tax free.

Examples of these types of accounts are the Roth IRA, Roth 401k , and, for our Canadian friends, the tax free savings account.

Tax-free or tax-exempt investment accounts are great for anyone who plans to retire in a higher tax bracket than they are now.

I also highly recommend these accounts because you never know what the future may hold and it is way better to have some tax free options in your bag that you can use should you need to in the future.

With all the amazing perks of investing in a tax-deferred or tax-free account, you may be wondering why would you invest in anything else.

Well, like with everything, there is a plus side and a downside. One of the biggest downside to using these tax advantaged accounts is that you have limited control over your investment options.

And this is even more so when it comes to investing in 401k plans. Your options depend on your companies plan which tend to be very limited, not very good, and have very high fees.

You can find more options with lower fees in traditional IRA accounts but what is lacking in both cases isflexibility.

When you use these tax advantaged accounts, you can't just take out your money when you want without being hit with early withdrawal penalties.

So, you may want to consider having a taxable brokerage account in addition to your tax-advantaged accounts.

*One exception to the withdrawal penalty is for Roth IRAs. You can withdraw your contributions without penalty but you have to wait 5 years before you can do so.

Now that you know how each of the above assets relates in terms of their tax efficiencies, you may be wondering how you could use that information to benefit you.

Well, the first thing you will want to do is to make sure you put those assets that are not very tax efficient, like bonds, into a tax advantaged account such as an IRA or 401k.

By doing that you won't be subject to all those tax liabilities that would arise if those assets had been in a taxable account.

Then those assets that are most tax efficient like municipal bonds, you'll want to place in your taxable brokerage account. Because they are tax efficient, there will be little to no tax liabilities from them on a regular basis.

• Avoid short term capital gains tax by holding your investments for longer than a year
• Use Tax Loss Harvesting - Selling losing shares before the end of the year to offset gains from well performing stock
• Any assets with substantial gains you may want to give to a charity to avoid taxes and get a write-off.
• During years of low income, consider moving some of your assets to a Roth IRA (to avoid taxes in the future)
• Consider Capital Gains Harvesting - Selling stocks for the capital gains (but making sure the amount is within the allowance to be tax free) then buying them back immediately. This will allow you to step up your cost basis regularly and limit capital gains. *Note: does not take into account State tax

As you move along on your journey to building wealth, your income will increase as well as your net worth. So as you and your money grow, you must look for ways to reduce your taxes and protect your wealth.

Use some of these tips given here to help you protect your money better so that you have a legacy to leave to your kids. As always do consult a certified financial advisor before making any decision.