Table of Contents
What is tax-efficient investing?
Taxable vs. tax-advantaged investment accounts
Tax-efficient investing strategies
Types of tax-efficient investments
The bottom line
Aug 31, 2022
7 min read
Tax-efficient investing is an approach to investing in which you endeavor to minimize or spread out your tax burden.
There are many factors to consider when constructing a personal investment strategy. Most investors have near-, mid-, and long-range goals, which can determine how they allocate money and what types of assets they hold. There’s also the matter of managing the costs of investing. Investing, like most things in life, isn’t free.
These costs generally fall into two broad categories: fees or commissions for investment advisers and related services, and taxes. Taxes, of course, are inevitable, but they can cut into your returns. There are ways to minimize, defer, and spread out the taxes you’ll pay through balancing your portfolio in a way that makes it more tax efficient.
Tax-efficient investing is an approach to investing in which you endeavor to minimize or spread out your tax burden. It involves choosing some investments for which you can defer tax payments and others that are taxed for the year you make gains on them.
Taxes can cut into investment returns in two ways:
There are a number of investing strategies that aim to achieve efficiencies when it comes to taxes. These are the steps you might want to consider when researching tax-efficient investments:
There are essentially two tax buckets into which investments fall: taxable and tax-advantaged. In taxable accounts, you pay taxes on your gains in the year that you earned the gains. In tax-advantaged accounts, you usually pay taxes later. The different kinds of accounts have various advantages and disadvantages. Most investors have a mix of both.
Assets such as stocks, bonds, exchange-traded funds (ETFs), and index funds held in taxable accounts will generate tax liabilities for any gains realized or income earned. In other words, if you sell a stock for a profit or receive dividends, you’ll pay taxes. The advantage of these taxable accounts is that they’re liquid. You can withdraw the money anytime, with no age restrictions and no penalties.
Investments in taxable accounts are subject to different tax rates. For instance, if you hold investments for at least a year, you would pay long-term capital gains rates, which are generally lower than short-term capital gains taxes. Long-term capital gains top out at 20%, depending on your tax bracket. If you hold an investment for less than a year, gains you make are subject to short-term capital gains taxes, which can go as high as 37%.
Tax-advantaged accounts are designed to encourage saving for retirement. But there are tradeoffs. For instance, if you take out money from certain types of accounts, you’ll pay taxes on the withdrawals. You’ll also sacrifice flexibility in exchange for the tax advantage.
Tax-advantaged retirement plans, such as 401(k)s, annuities, and IRAs, require you to wait until a certain age to withdraw. Early withdrawals often result in penalties in addition to the taxes due. These types of accounts also have yearly limits on how much you can contribute, and in the case of Roth IRAs, those with higher incomes may not be permitted to make any contributions.
Tax-advantaged accounts fall into two categories: tax-deferred and tax-exempt.
A tax-deferred account, such as a traditional IRA or 401(k), lets you deposit and invest money now, without paying income taxes until years later when you withdraw the money.
Roth accounts, meanwhile, are considered tax-exempt plans. You contribute to the plans with after-tax dollars, but your money gets to work tax-free and you won’t pay taxes on the withdrawals you take in retirement.
Try Titan’s free Investment Calculator to project your potential investment returns.Learn More
Investors often consider strategies to reduce or spread out their tax burden.
Some investors choose to diversify their portfolios by the way their investments are taxed. For instance, they might contribute to both a traditional IRA or 401(k) and a Roth IRA, in addition to keeping investments in a brokerage account.
Contributions to a traditional IRA are usually made with pretax money, so taxes would be paid on withdrawals at some point in the future—usually in retirement when most people have a lower tax rate. Contributions in a Roth IRA are made with after-tax dollars, and any withdrawals after the age of 59 ½ (from accounts that are at least five years old) are free of federal taxes, and in some cases, state taxes as well.
Since different types of investments are taxed at different rates, some investors choose tax-deferred accounts for investments that would normally incur higher tax rates. For instance, they might choose taxable accounts for individual stocks that they hold for a year or more, as those qualify for the lower long-term capital gains rate. And they might choose a tax-advantaged account for the investments that might yield the larger short-term capital gains and the higher taxes that would go with them.
Tax-efficient investing may change depending on an investor’s plans for managing an estate. For example, stocks that are passed on in an inheritance might be more appropriate for taxable accounts. Any taxes due if the shares are sold will be calculated starting with the cost basis, which is calculated based on the market value when an investor dies, not the price paid when the shares were bought years ago.
The tax code encourages philanthropy. You can deduct the value of charitable giving from taxable income, within some limits, and you can maximize the value of the gift in several ways. For instance, investors who contribute appreciated stocks or mutual funds instead of cash may be able to eliminate capital gains taxes. Investors can set aside multiple years of contributions in one year by donating through a donor-advised fund, which is a charitable fund created to manage charitable donations.
Some investments may be more tax-efficient than others:
, or ETFs, are pooled investments that are designed to track an index, sector, or commodity. ETFs held in a taxable account can be more efficient than a mutual fund in the same account because ETFs tend to generate fewer taxable events than a mutual fund, many of which buy and sell securities often, resulting in capital gains that lead to tax liabilities.
, or the debts issued by an agency or government to raise money, are tax-efficient because the interest income they pay isn’t subject to federal income tax. They can also be exempt from state and local taxes. But different municipal bonds can have different tax implications, so investors may need to consider the specific rules on individual bonds and consult a tax adviser.
, or real estate investment trusts, are pass-through businesses, which means that the business is not subject to corporate income taxes; rather, an investor’s proportional share of the trust’s profits are “passed through” to them as income to report on their individual tax return. To qualify as a REIT, the trust has to distribute the vast majority (90%) of its taxable income to shareholders. Still, you’ll want to talk to a financial adviser about how that dividend will be taxed. It will generally be treated as ordinary income but could be classified as a capital gain or a return on capital.
Tax implications can be critical for investors, whether they are saving for retirement, generating cash, or looking for ways to leave an inheritance or donate to charity. By holding various types of investments in the appropriate accounts, investors can spend less on taxes and limit the opportunity cost of having less money to invest today.
At Titan, we are value investors: we aim to manage our portfolios with a steady focus on fundamentals and an eye on massive long-term growth potential. Investing with Titan is easy, transparent, and effective.
Get started today.
Certain information contained in here has been obtained from third-party sources. While taken from sources believed to be reliable, Titan has not independently verified such information and makes no representations about the accuracy of the information or its appropriateness for a given situation. In addition, this content may include third-party advertisements; Titan has not reviewed such advertisements and does not endorse any advertising content contained therein.
This content is provided for informational purposes only, and should not be relied upon as legal, business, investment, or tax advice. You should consult your own advisers as to those matters. References to any securities or digital assets are for illustrative purposes only and do not constitute an investment recommendation or offer to provide investment advisory services. Furthermore, this content is not directed at nor intended for use by any investors or prospective investors, and may not under any circumstances be relied upon when making a decision to invest in any strategy managed by Titan. Any investments referred to, or described are not representative of all investments in strategies managed by Titan, and there can be no assurance that the investments will be profitable or that other investments made in the future will have similar characteristics or results.
Charts and graphs provided within are for informational purposes solely and should not be relied upon when making any investment decision. Past performance is not indicative of future results. The content speaks only as of the date indicated. Any projections, estimates, forecasts, targets, prospects, and/or opinions expressed in these materials are subject to change without notice and may differ or be contrary to opinions expressed by others. Please see Titan’s Legal Page for additional important information.
You might also like
What Is Free Cash Flow?
Free cash flow shows how much money a company has at its disposal after all costs, including capital spending, to maintain business operations. Find out more here.
What Is the Standard Deduction & How Do You Calculate It?
Most taxpayers qualify for the standard deduction if they prefer to use it over itemized deductions. The amount that can be claimed depends on the person’s filing status.
Understanding the Capital Gains Tax and How to Calculate It
Capital gains build wealth and grow assets, these are taxed differently depending on a number of factors like how long the asset was owned and how much the taxpayer earns.
© Copyright 2023 Titan Global Capital Management USA LLC. All Rights Reserved.
Please refer to Titan's Program Brochure for important additional information. Certain investments are not suitable for all investors. Before investing, you should consider your investment objectives and any fees charged by Titan. The rate of return on investments can vary widely over time, especially for long term investments. Investment losses are possible, including the potential loss of all amounts invested, including principal. Brokerage services are provided to Titan Clients by Titan Global Technologies LLC and Apex Clearing Corporation, both registered broker-dealers and members of FINRA/SIPC. For more information, visit our disclosures page. You may check the background of these firms by visiting FINRA's BrokerCheck.
Various Registered Investment Company products (“Third Party Funds”) offered by third party fund families and investment companies are made available on the platform. Some of these Third Party Funds are offered through Titan Global Technologies LLC. Other Third Party Funds are offered to advisory clients by Titan. Before investing in such Third Party Funds you should consult the specific supplemental information available for each product. Please refer to Titan's Program Brochure for important additional information. Certain Third Party Funds that are available on Titan’s platform are interval funds. Investments in interval funds are highly speculative and subject to a lack of liquidity that is generally available in other types of investments. Actual investment return and principal value is likely to fluctuate and may depreciate in value when redeemed. Liquidity and distributions are not guaranteed, and are subject to availability at the discretion of the Third Party Fund.
The cash sweep program is made available in coordination with Apex Clearing Corporation through Titan Global Technologies LLC. Please visit www.titan.com/legal for applicable terms and conditions and important disclosures.
Cryptocurrency advisory services are provided by Titan. Cryptocurrency trading is provided by Bakkt Crypto Solutions LLC ("Bakkt Crypto"). Bakkt Crypto is not a registered broker-dealer or a member of SIPC or FINRA. Cryptocurrencies are not securities and are not FDIC or SIPC insured. Bakkt Crypto is licensed to engage in virtual currency business activity by the New York State Department of Financial Services. Cryptocurrency execution services are provided by Bakkt Crypto (NMLS ID 1828849) through a software licensing agreement between Bakkt Crypto and Titan. Please ensure that you fully understand the risks involved before trading: bakkt.com/disclosures.
Information provided by Titan Support is for informational and general educational purposes only and is not investment or financial advice.
Contact Titan at firstname.lastname@example.org. 508 LaGuardia Place NY, NY 10012.