Not all investments are created equal. Some investments are more tax efficient than others. As you are allocating your portfolio, consider the type of account you place an investment in.
Asset Allocation
1. Taxable Accounts
- In taxable accounts, hold tax efficient investments such as:
- Exchange Traded Funds (ETF) and indexed mutual funds may have lower turnover rates, resulting in fewer taxable events.
- Tax managed funds are specifically designed to minimize taxes through strategies like low turnover and tax-loss harvesting.
- Municipal Bonds and tax-exempt mutual funds pay interest income that is usually exempt from Federal taxes and possibly State taxes.
- In taxable accounts you want to hold investments for a year or longer to benefit from lower capital gains tax rates. You may also consider selling underperforming investments if they have a capital gain loss. You can use ‘tax harvesting’ to offset other capital gains.
2. Tax Advantaged Accounts
- IRAs and 401(k)s are Tax Advantaged accounts that grow tax free. In these accounts, hold income generating investments such as:
- Mutual Funds can create income with dividends. They also may have capital gains that must be paid out annually.
- REITS generate a cash flow or dividends that are paid to investors.
- Corporate bonds or bond mutual funds pay interest income.
- Maximize your contributions for Tax Advantaged accounts.
3. Roth Accounts
- Roths are tax free accounts. In a Roth, hold growth investments to maximize the tax-free growth potential. Investments such as:
- Growth stocks
- Growth mutual funds
- Growth ETFs
- Roth accounts are beneficial in making large distributions that don’t change the tax picture.
Investment Income is also subject to the Net Investment Tax (NIT) of 3.8%. Investment income is interest, dividends, capital gains, royalty income, passive rental income, and other passive income. Distributions from IRAs and 401(k) plans are not subject to NIT but they can push your income into the Net Investment Tax range. The tax threshold is:
- Married filing joint: $250,000
- Married filing separate: $125,000
The amount that may be subject to the 3.8% NIT is the lesser of 1) net investment income, or 2) the amount that exceeds the threshold.
As you complete your tax return this year, review your investments and their contribution to your taxable income. Call our office at (208) 343-7777 for a complementary review of your portfolio and tax implications.