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  • Michael Livian, CFA

Year-End Tax Optimization for Investors: A Guide to Smarter Savings

Time for Tax Planning

As we approach the end of the year, it’s a crucial time for investors to take a close look at their portfolios and make smart decisions that can optimize their income taxes. Below, we’ll walk you through a comprehensive yet straightforward guide to ensure your investments are as tax efficient as possible.

1. Maximize Your Deductions

Retirement Account Contributions

One of the simplest ways to reduce your taxable income is to maximize your contributions to your traditional Individual Retirement Account (IRA) or any other qualified account. For 2023, you can contribute up to $6,500, or $7,500 to your IRA, if you’re age 50 or older. Not only do these contributions potentially lower your tax bill, but they also bolster your retirement savings.

Charitable Contributions

Charitable giving is not only altruistic but can also be tax-savvy. Consider donating to qualified charities before year-end to receive a tax deduction. Remember, if you itemize your deductions, you can deduct these contributions. For those who are charitably inclined but not ready to commit to specific charities, a donor-advised fund can be a great tool, allowing you to make a deductible contribution now and decide on the recipients later.

2. Asset Location Strategies

Taxable vs. Tax-Advantaged Accounts

Be strategic about where you hold different types of assets. High-growth investments may be better suited in tax-deferred or tax-exempt accounts to shield their returns from immediate taxation. Conversely, tax-efficient investments, like index funds, might be held in taxable accounts due to lower turnover and capital gains distributions.

3. Tax-Advantaged Instruments

Municipal Bonds

Municipal bonds (munis) are a staple in tax-advantaged investing, particularly for investors in higher tax brackets. The interest from most munis is exempt from federal income taxes and, in some cases, state and local taxes.

U.S. Treasuries

Interest from U.S. Treasuries is exempt from state and local taxes, which can be beneficial depending on your place of residence and tax situation.

Qualified Dividend Income (QDI) and Master Limited Partnerships (MLPs)

Investing in stocks that pay qualified dividends can lead to lower tax rates on the income received, while MLPs offer tax-deferred distributions, which can be beneficial for long-term growth.

4. Tax Loss Harvesting

Capitalizing on Market Downturns

Tax loss harvesting involves selling investments that are at a loss and using those losses to offset any capital gains taxes. Given the volatility in the fixed income market over the past few years, there may be opportunities to realize losses that can reduce your tax liability.

5. Advanced Tax Strategies

Direct Indexing

This is a personalized form of investing where you own the underlying securities of an index, allowing for greater control over the tax implications of your investments. You can sell individual securities that are at a loss while maintaining your overall investment exposure.

Options Overlay Strategies

Sophisticated investors might use options as a strategy to hedge their positions without selling their appreciated assets. This can be particularly advantageous if you have positions with significant unrealized gains.

Practical Steps to Take Now

1. Review Your Portfolio: Examine the tax implications of your holdings and consider rebalancing if necessary.

2. Contribute to Retirement Accounts: Ensure you’ve maximized your contributions to your IRA or 401(k).

3. Charitable Giving: If you’re planning on charitable contributions, do so before year-end to include them in this year’s tax deductions.

4. Assess Your Investments: Determine if your investments are in the most tax-efficient accounts.

5. Consider Tax-Advantaged Bonds: If you’re in a high tax bracket, munis and U.S. Treasuries might be suitable for your portfolio.

6. Tax Loss Harvesting: Work with a financial advisor to identify opportunities for tax loss harvesting.

7. Consult a Tax Professional: Before implementing advanced strategies like direct indexing or options overlays, consult with a tax professional to understand the implications.

In conclusion, tax planning is an integral part of investing. It’s not just about the returns you earn, but also about how much you keep after taxes. While these strategies can be implemented at any time, the end of the year provides a natural deadline to ensure you’re positioned well for tax season. As always, it’s important to consult with a financial professional to tailor these strategies to your specific situation. By taking proactive steps now, you can make informed decisions that could significantly reduce your tax liability and enhance your financial well-being.


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