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Jun 14, 201910:34 AMOpen Mic

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10 portfolio strategies to help save on your income tax bill

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With the passing of the April 15 tax-filing deadline, most people have now felt the impact of the changes to the tax code. For many, the loss of significant itemized deductions may have them re-examining their tax return for tax savings opportunities. As a result, it may be a good time to review the impact your investment portfolio may be having on your income tax bottom line.

Taxes matter a lot. Although every taxpayer’s situation is different, it has been estimated that proper tax management of your portfolio may be able to improve your after-tax returns by 1–2 percent a year. While this seems like a small amount in any single year, the long-term compounding benefit could be significant!

If you have taxable investments outside of retirement accounts like IRAs and 401(k)s — retirement accounts don’t pay income tax until the funds are taken out — then there are multiple strategies to help control income taxes. Here are 10 such strategies:

1. Mutual funds with tax-sensitive mandate

Some or all of your portfolio could include mutual funds that have tax minimization as part of their mandate. The managers of these funds, as part of their investment approach, are required to minimize tax distributions to shareholders, so they utilize some of the strategies discussed in this article. Mutual funds don’t pay income taxes. Instead, they distribute all of the income and gains out to shareholders who pay the tax. It may come as a surprise to many investors, but unless the fund manager is explicitly required to minimize taxes, then the manager is not likely doing so. We highly recommend reviewing the fund prospectus carefully before purchasing a mutual fund. Prospectuses are required to disclose the fund’s strategies, among other things, including whether tax minimization is part of the strategy.

2. Municipal bonds

Tax-exempt municipal bonds can be used instead of corporate bonds to provide tax-advantaged income. If you are in a federal tax bracket of 24 percent or higher, you should consider investing in municipal bonds. Interest on these bonds will not be taxed for federal purposes, but rather only as state income (state rates are generally much lower than federal rates). In some states the bonds may be tax free for both state and federal, depending on the type of bond.

3. Qualified dividends

Certain dividends known as qualified dividends are subject to the same tax rates as long-term capital gains, which are lower than rates for ordinary income. To qualify for the lower capital gain rate, qualified dividends are generally dividends from shares in U.S. corporations and certain qualified foreign corporations that you have held for at least a specified minimum period of time (too complicated to dive into for this article). The qualified dividends are reported separately on year-end tax reporting statements. If a significant portion of your dividends are not in this “qualified” bucket, then you may want to discuss the matter with your financial advisor/broker and/or tax advisor.

4. Tax-loss harvesting

Tax-loss harvesting is used to sell securities at a loss to offset taxable gains now or in the future. Almost everyone had some losses in 2018 as markets declined significantly in the fourth quarter. Did you take advantage of this downturn? Tax-loss harvesting involves selling an investment at a loss and immediately reinvesting the proceeds of the sale back into the same asset class. This allows you to secure a loss to offset gains on your tax return, without compromising your investment strategy and the overall makeup of your portfolio. In addition to offsetting gains, you can deduct capital losses up to $3,000 against ordinary income on your federal tax return. As markets recover, you have both the recovered value of the portfolio and a tax loss to use on your tax return.

5. Minimize trading

The more trading that occurs in the portfolio, the more tax that will likely be incurred on the realized gains. If you are seeing a lot of trades on the year-end tax reporting statement, discuss with your broker/advisor the reasons for the trades. It could be a red flag. This is a particular area where many investors simply defer to their advisor’s assumed knowledge. Frequent trading often leads to higher expenses (see next paragraph) in the portfolio and does not necessarily achieve the investor’s goals and objectives.


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