Financial Planning – Tax Efficiency Explained

The way you plan your investments right now can determine your tax burden for years or decades. Tax-efficient techniques can help you effectively invest your resources and improve your overall…

June 27, 2022

Written by John Wonneberger

The way you plan your investments right now can determine your tax burden for years or decades. Tax-efficient techniques can help you effectively invest your resources and improve your overall wealth management strategy. While many people focus on how much an investment earns, it’s equally important to pay attention to how much you spend on taxes each year. In some cases, efficient tax management will bring in significantly more net profits than the most profitable investment.

When you work with a tax-efficient investment firm, you can learn how to save on taxes. You can mitigate your exposure to current and future taxes by using intelligent investment strategies. Because of this, you can end up building more wealth over time. If you want to save for a loved one’s inheritance or donate some of your wealth, you can use these goals to save money on your tax return. Read through the article to improve your knowledge on tax-efficient investing.

What Is Tax Efficiency?

Tax efficiency is an important part of wealth management. Right now, the top income tax bracket is 37 percent. For most people, the capital gain tax rate works out to 15 percent. Whether you live off of a retirement account or employment income, these taxes can significantly impact your bottom line.

With tax efficiency, you can learn how to legally pay the least amount of taxes possible. This technique follows applicable laws to reduce your tax burden. For example, some people can reduce their tax bills by opening a 401(k) plan, an individual retirement account (IRA), or a similar tax-deferred account.

Other than tax-deferred accounts, there are different ways to reduce your tax bill each year. For example, municipal bonds are exempt from federal taxes. Additionally, tax-efficient mutual funds entail a lower tax rate than standard mutual funds.

Why Is Tax Efficiency Important?

If your goal is to increase your net worth, wealth management and tax efficiency are incredibly important. Taxes reduce the amount of money that you get to keep. This has an immediate impact on your bottom line in the short term.

Unfortunately, high taxes can have an even larger impact on your long-term wealth accumulation. When you pay your taxes each year, you can no longer invest those funds. Because of this, you lose out on the dividends and interest those funds would’ve earned. To maximize your returns and increase your overall net worth, you need to learn about tax-efficient investing.

Investment Accounts

When you work with a financial advisor, you can learn about different investment accounts. In general, you’ll be able to invest in taxable accounts or tax-advantaged accounts. While each account type has advantages and disadvantages, tax-advantaged accounts will lead to a lower tax bill now or in the future.

Taxable Investment Accounts

If you invest with a stockbroker, your brokerage account is likely taxable. While a taxable account doesn’t help you defer taxes, it’s easy to invest in different financial vehicles. Unlike a 401(k) plan or IRA, you can invest as much as you want and withdraw your profits without paying a penalty fee.

Even though taxable accounts involve taxes, there are still techniques that can help you reduce your overall tax bill. Typically, you have to pay capital gains tax on your earnings if you have held the investment for a year or more. This tax rate will be 0, 15, or 20 percent. If you only hold the investment for less than a year, you have to pay taxes based on your ordinary income tax bracket. In most cases, this means your short-term investments will involve a much higher tax bill than long-term investments.

Tax-Advantaged Accounts

To really reduce your tax bill, you should use tax-advantaged accounts. These accounts involve deferring or exempting your taxes. Traditional IRAs and 401(k) plans are good examples of tax-deferred accounts. When you put money in these plans, you can generally deduct the contributions from your taxes for an instant tax break. Eventually, you end up paying taxes on the money you withdraw when you retire.

Tax-Exempt Accounts

A tax-exempt account works in the opposite direction. Instead of deferring taxes on your contributions, you can avoid paying taxes on your withdrawals. When you contribute to a Roth IRA or Roth 401(k), you use after-tax dollars. Because you pay taxes on your contributions, you get to withdraw funds without paying taxes after you retire. If you expect your income to be higher after you retire, tax-exempt accounts are generally a good idea.

How Can You Reduce Your Taxation Level?

There are many ways you can save on taxes by changing your overall investment strategy. Other than focusing on long-term capital gains, you can create an irrevocable trust to reduce your tax bill. You can also buy tax-exempt bonds or tax-efficient mutual funds.

Long-Term Capital Gains

One of the key ways you can achieve tax efficiency is by waiting a year to sell your stocks after you buy them. If you sell them in less than 12 months, your profits will be taxed like normal employment income. You can also reduce your overall tax bill by balancing your current gains with previous capital losses.

Irrevocable Trusts

An irrevocable trust is helpful for estate planning, so it’s a popular wealth management service. You no longer own your assets when you put them into an irrevocable trust. Once they’re in the trust, the decision is irreversible.

In essence, an irrevocable trust allows you to remove some of your assets from your estate. This means that you’re no longer responsible for paying taxes on the trust’s assets. Because of this, you can use irrevocable trusts when you want your loved ones or a charity to inherit your estate.

Tax-Efficient Mutual Funds

A tax-efficient mutual fund is a good option if you don’t have a tax-advantaged account. These mutual funds are taxed at a lower rate than standard mutual funds. Normally, this is because they create lower capital gains and dividends than standard accounts. Often, tax-efficient mutual funds are invested in exchange-traded funds (ETFs) or index funds.

Tax-Exempt Bonds

Municipal bonds are the main example of tax-exempt bonds. As long as you invest in a municipal bond, you don’t have to pay federal taxes on it. Because of this, municipal bonds may be a more profitable choice than corporate bonds.

How Can a Financial Advisor Help?

Many financial advisors focus on figuring out which stocks and bonds are the most profitable investments. Among affluent investors, it’s essential to get a financial advisor who knows how to reduce tax bills. Tax-efficient strategies help maximize the amount of money you get to keep each year, which can improve your overall net worth. When you work with an advisor specializing in tax efficiency, you can enjoy some of the following benefits.

  • You can figure out tax-efficient strategies for estate planning.
  • The advisor can discuss opportunities that can help you boost your return without adding any additional risks.
  • You can avoid having a surprisingly horrible tax bill at the end of the year.
  • Tax-efficient strategies can help you reduce your tax bill over the long run.

If you invest without considering the tax consequences, your investments may lose you money. You have to think about the total ramifications of each investment. The right advisor understands tax strategies, so they can tell you which investments will pay off the most. They can help you manage risk and avoid unnecessary taxation in the future. When you create capital gains each year, your advisor can help you figure out the best way to mitigate the tax implications.

How To Get The Most Out Of A Financial Advisor?

To get the most out of working with a financial advisor, you should be prepared to share your financial information. This includes your income, debts, investments, and expenses. You should also have a good understanding of your financial goals and communicate these to your advisor.

Your financial advisor can help you create a plan to achieve your goals. They can also give you advice on how to reduce your overall taxation level. However, they can’t do everything for you. Ultimately, it’s up to you to make the decisions that will affect your finances.

Remember that you’re the one in control of your money. A good financial advisor will give you advice and guidance, but they won’t make decisions for you. You should be comfortable with the risks you’re taking and your choices. You need to be able to trust your advisor and feel like they have your best interest in mind.

Nesso Wealth – Get Reliable Help With Your Wealth Management

By building a financial plan with your advisor, you can create intelligent, long-term decisions about your financial future. Whether you want assistance with wealth management or retirement planning, financial advisors can help. At Nesso Wealth, you can learn about the best financial strategies for your unique situation.

Based out of Connecticut, Nesso Wealth is known for making complex financial topics simple to understand. Clients can learn how to plan for retirement, reduce their tax burden, and manage their investments. In addition, Nesso Wealth can help with estate planning and overall financial planning. To learn more about tax-efficient strategies, reach out to Nesso Wealth today.

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