Three Tax Savings Investors Miss Because Their Adviser Was Never Trained on Tax

Nearly every financial decision has a tax implication attached, and that is especially true of investment decisions. It is also not unusual, according to Paula Thielen, managing partner and financial adviser at Thielen and Associates, for advisers to lack the training needed to advise on the tax side at all.

Where that gap exists, three specific opportunities tend to go unused.

Asset location, which is not asset allocation

The first is the most technical and the most commonly skipped.

Asset location means putting each investment in the account whose tax treatment suits it, in order to improve the after-tax return. It is distinct from asset allocation, which decides what you own rather than where you hold it.

The logic runs like this. Tax-deferred accounts, such as a traditional individual retirement account, are not taxed until money is withdrawn. Putting assets that grow modestly into that wrapper avoids paying a recurring bill on small gains, such as annual bond interest.

Investments that move around more, individual stocks and exchange-traded funds, can sit in taxable accounts, which are taxed each year on interest, dividends and capital gains. That placement has an advantage of its own: a stock trading below its purchase price can be sold at a loss to offset gains elsewhere and reduce the overall bill.

Diversification, risk tolerance and liquidity needs all still apply and none of this overrides them. But getting the placement right reduces what Thielen calls tax drag, which means more money stays invested and compounding.

Inherited IRAs must be depleted within ten years, and leaving it to the final years is expensive

Timing withdrawals from retirement accounts

At 73, investors are required to take minimum withdrawals each year from tax-deferred retirement accounts. From 59 and a half, they are permitted to withdraw without penalty.

The gap between those two ages is where the planning happens. Required distributions should be taken when taxable income is at its lowest, so that the withdrawal does not push the recipient into a higher bracket.

The version that costs people most is an inherited account. An inherited IRA has to be emptied within ten years, and leaving the large distributions until the final years of that window can generate a substantial tax charge.

Which makes it worth watching for a change in circumstance. If someone reduces to part-time work, perhaps to care for a surviving parent, their taxable income falls, and that year becomes a considerably better one in which to take money out.

Rebalancing in the right account

The third is about where a portfolio gets adjusted rather than how.

A portfolio sets a target allocation between stocks and bonds based on goals, time horizon and risk tolerance, commonly around 70 per cent stocks and 30 per cent bonds. The objective is to hit that target across every account in the household, including tax-deferred retirement accounts and taxable brokerage accounts, viewed as one portfolio rather than several.

Once that view is taken, the rebalancing can be done wherever it is cheapest. Trading inside a tax-deferred account produces no immediate tax event. Selling in a taxable brokerage account to achieve the same result produces a capital gains bill.

The same applies to an inherited IRA, which can be used to bring the overall allocation back to target without triggering a charge elsewhere.

The common thread

None of these three is exotic, and none requires a view about markets.

Each is simply a question of matching asset types to account types, timing withdrawals against income, and rebalancing where it does not cost anything. What they have in common is that noticing them requires an adviser who understands the tax code as well as the portfolio.

This is general information rather than investment, tax or financial advice, and anybody's own position should be checked with a licensed professional.