Tax-Smart Investing in Retirement

In retirement,managing taxes should be a key element in your personal financial plan. One of the biggest challenges you may face is achieving a higher level of tax savings in your taxable investment accounts, while making the most of your tax-advantaged retirement accounts. Your wealth manager can help you make tax-smart investment decisions in all of your accounts, while helping you plan for your future growth and income needs in retirement.

Here are some tips for managing taxes and keeping more of what your investments earn:

1. Look for high-quality, tax-advantaged investments.

The true return on your portfolio is how much you keep after taxes. For this reason, many investors in the highest income tax brackets are attracted to municipal bonds, which are free from federal income tax. Municipal bonds are also free from state income tax when you buy bonds issued in the state of your primary residence. Focusing on your after-tax performance through tax-advantaged investments like high-quality municipal bonds can help you enhance your long-term returns, while potentially reducing investment risk.

For example, let’s say you are in the 25% tax bracket. A municipal bond paying 5% interest produces the same after-tax return as a corporate bond paying 6.67%. By buying a municipal bond, you have the potential to get the same after-tax return as a corporate bond, but with much lower risk. Studies by leading bond rating agencies show that even average-rated municipal bonds have a much lower risk of default than the highest rated corporate bonds.

2. Choose the right account structure for your needs.

For first-time investors, mutual funds are an easy way to get started. They offer professional management, instant diversification and low investment minimums, making them a popular vehicle for retirement plans and IRAs. However, as your investments grow over time, mutual funds have a tendency to show their limitations. For example, fees and expenses can be high, you can’t control when securities are bought or sold in a fund’s portfolio and fund managers are required to keep cash on hand for redemptions, reducing a fund’s investable assets. As a result, mutual funds often aren’t very tax-efficient for investors in higher income tax brackets.

If you have investable assets of $500,000 or more, you may want to consider a separately managed account. As the name implies, with a separately managed account, your money is kept separate from other investors. Investment decisions can be tailored to your specific needs, including your tax and estate planning needs. Your investment manager can employ sophisticated financial planning techniques, such as tax loss harvesting, to help you optimize tax breaks and enhance your long-term performance. And finally, with a separately managed account, your money can remain fully invested at all times.

3. Take advantage of lower tax rates on dividends and long-term capital gains.

Account earnings generated from stock dividends and long-term capital gains are currently taxed at a maximum rate of 15%. In contrast, earnings generated from short-term capital gains may be taxed at your ordinary income tax rate, which could be as high as 25% or more. For high net worth investors, this tax rule tends to make separate accounts much more tax efficient than mutual funds. In a separately managed account, your portfolio manager will decide when and how to sell securities based on your specific tax needs, as well as performance considerations.

4. Take a team approach to managing your wealth.

Successful wealth management integrates a broad range of disciplines, including tax planning, estate planning, insurance coverage, mortgage loans and daily banking solutions. The most successful investors today, such as Warren Buffett, have a large team of professionals working in concert to achieve their long-term goals. Fortunately, you don’t have to be Warren Buffett to create your own team of professionals. An independent wealth manager can serve as a central point of contact among your trusted advisors, such as your attorney, CPA, insurance agent and personal banker. By serving as the “quarterback” for your financial plan, your personal wealth manager can help you stay in the game longer and keep more of what you earn by implementing more tax-efficient investment strategies.

5. Review the tax efficiency of your portfolio once a year.

Tax laws are constantly evolving. For investors who are approaching or currently enjoying retirement, it’s especially important to keep up with recent developments in areas such as the alternative minimum tax and the estate tax. Talk to your wealth manager and tax professional about your current tax liabilities, while looking for opportunities to reduce taxes. It’s a good idea to review the tax efficiency of your portfolio once a year from a variety of angles, including your estate plan, your retirement plan, your current tax bill and your future financial goals.

Taking a few easy steps can often help you increase the tax efficiency of your overall portfolio. Remember, you don’t have to tackle your financial plan alone. Asking for guidance and advice along the way can help you spend less time on managing your finances and more time on the things that are most important to you.