When it comes to investing, taxes can have a major impact on your returns. It is important to understand how taxes are treated differently between different accounts, and how best to manage asset location in order to minimize tax liability, resulting in better net investment returns. In this blog post, we will discuss the importance of investment account registration types, managing taxes in retirement, distributions from investment accounts at death, and the benefits of growth stocks in taxable investment accounts or Roth IRA accounts instead of pre-tax IRA accounts.

Asset Location

Before delving into the specifics of investment tax strategies, it is essential to understand the concept of asset location. Asset location is all about understanding which assets should be held in which type of account in order to maximize after-tax returns and minimize tax liabilities when they arise. For example, if a pre-retiree has an IRA account with $1M growth stocks and a bank account with $1M CDs, the interest being paid by the CDs is federally taxed annually at ordinary income tax levels while the capital gains of the growth stocks is increasing the future federal tax liability, also taxed at ordinary income tax rates when distributed from the IRA account. You may want to consider changing the ownership of each type of asset, selling some stock ownership withing the IRA to purchase CDs or bonds with fixed rates while also redeeming some CDs held at the bank to fund a taxable investment account that offers more favorable tax treatment for capital gains of growth stocks. Now, the interest earned on the CDs within the IRA is able to compound annually, deferring federal income tax until distributed from the IRA. Capital gains on the growth stocks will be taxed at the lower capital gains rates, at a future date when sold. That way, you can benefit from any appreciation without having to pay higher taxes on it when you sell.

Managing Taxes in Retirement

When it comes time for retirement, managing your taxes becomes even more important. Since most retirees do not have any income other than their retirement assets and Social Security benefits (if applicable), there are often fewer options available for reducing their tax burdens. However, there are still ways to reduce your taxable income by managing the distribution amounts from each investment account registration types and making Qualified Charitable Distributions if applicable. Making coordinated distributions from a taxable account, a pre-tax account and a Roth IRA can allow retirees to spend +$25,000 per month, while staying in a moderate 22% federal tax bracket for married/joint tax filers. Additionally, converting some assets from pre-tax retirement accounts into Roth IRA accounts can help reduce future taxable income since withdrawals from these types of accounts are not taxed.

Distributions from Investment Accounts at Death

In many cases, an individual's estate or beneficiaries will end up owing taxes on any investment accounts that were passed down upon their death. This generally occurs when those investments were held within pre-tax retirement accounts such as 401(k)s or traditional IRAs; since withdrawals taken during life are generally taxed at ordinary income rates (which can be quite high), so too are distributions taken after death. Investments held in a Roth IRA are not taxed upon death. Investments held in a taxable account upon death receive a step-up in cost basis which means the original cost of the investment becomes adjusted for beneficiaries to the date of death of the original owner or the date of death plus six months. The is greatly beneficial when considering strategic asset location for investments during your life while also considering minimizing taxes upon your death.

Conclusion

Investing for retirement or other long-term financial goals requires careful thought and consideration when it comes to managing taxes properly. By understanding the basics of asset location and its impact on taxation rates now—as well as implementing strategies like taking advantage of deductions/credits or transferring assets between different types of investments—you can ensure that your hard earned money goes farther while minimizing future tax liabilities both during life and after death.

At Provident Financial Planning, our team of CERTIFIED FINANCIAL PLANNER™ and CPA/JD tax experts utilize a strategic planning process to implement the best strategy customized for you, so you can rest assured knowing that your investments are being managed properly while providing maximum tax benefits over time! If you are looking for a financial advisor in the Dallas-Fort Worth area, click the link below to schedule a free retirement strategy meeting at our Dallas, Plano or Southlake offices. As a Registered Investment Advisor (RIA) with the United States Securities and Exchange Commission (SEC) we are licensed to advise clients in all fifty states and the link below will also conveniently allow us to meet with you via Zoom.

Make an appointment for a free consultation to speak with the Provident Financial Planning team of Certified Financial Planner™ and JD/CPA tax experts, so we can advise you on how to implement an investment, tax, and legacy strategy that is tailored to you.