Establishing a tax management strategy for your investments may help you keep more of your returns.
Applying an active tax-management strategy for your investments may help reduce your overall tax burden.
Even investors who spend a lot of time thinking about how to maximize their portfolios for performance may lack a strategy when it comes to minimizing taxes on those returns.
Even small reductions in tax payments today can have a big impact on your wealth tomorrow. Consider putting in place some or all of the following potential solutions.
Different kinds of accounts are subject to different tax rules. A tax-aware asset location strategy that accounts for those differences may increase your after-tax returns. For example, by allocating taxable assets which may generate income, such as dividend-paying stocks and corporate fixed income, to tax-deferred and tax-exempt accounts (e.g. Individual Retirement Accounts), you can help minimize your exposure to current taxes. In contrast, consider purchasing nontaxable assets, such as municipal bonds, in taxable accounts. Your Financial Advisor can assist you and your tax advisor in structuring a tax-aware asset location strategy across your accounts.
Many investments allow you to save for a variety of goals while also offering tax benefits. Municipal bonds, which are typically exempt from federal (and in many cases, state and local) taxes, for example, can be a tax-efficient investment against current and potentially higher tax rates. Beyond municipal bonds, consider tax-efficient mutual funds or separately managed accounts that aim to limit the number of taxable events within your portfolio.
If you’re saving to cover future education costs, a 529 savings plan is a tax-advantaged way to save for qualified educational expenses, such as college tuition.
For retirement savers, diversifying your retirement portfolio with a variable annuity may provide tax-deferred growth potential, guaranteed lifetime income, increased retirement savings, equity upside potential, and a death benefit for named beneficiaries.
Finally, if you’re charitably inclined, consider giving to a donor-advised fund (DAF). When you donate to a DAF, you may become eligible for a federal income tax deduction on the contribution if you itemize deductions, while also retaining advisory privileges to recommend which charities should receive the donated amount currently or in later tax years. This amount may grow through investments over time.
Current U.S. federal tax law permits tax-loss harvesting, a process by which you can offset capital gains with capital losses incurred during that tax year, or carried over from a prior tax year, potentially lowering your overall federal income tax liability. This can be a particularly useful strategy during years, like the past one, where markets have experienced significant turbulence.
Capital gains are generally the profits you realize when you sell an investment (e.g. stock, personal real estate, art, etc.) for more than you paid for it, and capital losses are generally the losses you realize when you sell an investment for less than you paid for it.
If your capital losses exceed your capital gains, the excess capital losses can offset up to $3,000 of ordinary income each year. You can carry forward any additional excess capital losses as potential tax offsets in future years.
While you may want to use the proceeds from harvested losses to purchase other investments, you’ll want to make sure you don’t inadvertently participate in a “wash sale,” which occurs when you sell or trade stock or other securities at a loss, then buy substantially identical stock or other securities within 30 days before or after the sale date. Talk to your Financial Advisor about your options.
Consider maxing out contributions to your account through your employer’s retirement benefits, such as a 401(k) plan, since contributions typically occur on a pretax basis. Contributing to a traditional IRA can also lower your taxable income for the current year, since contributions may be tax-deductible.1 Because these are tax-deferred accounts, you generally won’t pay income taxes on contributions, or any earnings from your investments, until you withdraw funds.
For the 2023 tax year, you can contribute up to $22,500 ($23,000 in 2024) to your 401(k) account. If you’re saving in a traditional IRA, you have until the tax deadline (April 15, 2024 for the 2023 tax year) to contribute up to $6,500 in 2023 or $7,000 in 2024. In 2023 and 2024, those age 50 or older can boost those contributions by $7,500 in their 401(k) or $1,000 in a traditional IRA.2
For 2023, the federal estate tax exemption increased to $12.92 million per individual and $25.84 million for a married couple. In 2024, those limits go up to $$13.61 million for individuals and $27.22 million for married couples.3 Unless Congress makes a change, the estate tax exemption will be reduced to pre-2018 levels starting in 2026. Regardless of whether you will generate estate taxes, all investors should have an estate plan that reflects their wealth-transfer goals and objectives.
Trusts can be an effective tool to reduce estate taxes or assure a fair distribution of wealth among family members. Taxpayers with taxable, or potentially taxable, estates who would like to leave money to their family members should consider making lifetime gifts to those family members now. This can be a tax-efficient wealth-transfer strategy because it removes any future appreciation in the gift’s value from the client’s taxable estate.
Also, consider making annual exclusion gifts to individuals before year-end; for 2023, these can be gifts of up to $17,000 per recipient for individual taxpayers and $34,000 for married couples electing to split gifts. In 2024, those limits rise for $18,000 for individuals and $36,000 for married couples electing to split gifts.4 Keep in mind that gifts in the form of tuition payments made directly to an educational organization, as well as medical expense payments made directly to the provider, are not taxable gifts and do not count against the annual exclusion amount for gifts or reduce your federal lifetime gift tax exemption.
With Total Tax 365, Morgan Stanley Financial Advisors offer tax-smart techniques and strategies to help you reduce the impact of taxes, all year round. Talk to your Morgan Stanley Financial Advisor to learn more.
In addition, if you have complex tax planning needs, your Morgan Stanley Financial Advisor can connect you to experienced tax professionals at leading U.S.-based providers across the country to help ensure your tax strategy is optimized.
Footnotes
1 Contributions to traditional IRAs may be tax-deductible depending on your modified adjusted gross income and federal tax filing status. Consult with your financial advisor/tax advisor to see which account is right for you.
2 IRS. “401(k) limit increases to $23,000 for 2024, IRA limit rises to $7,000” https://www.irs.gov/newsroom/401k-limit-increases-to-23000-for-2024-ira-limit-rises-to-7000 Accessed on November 28, 2023
3 IRS “IRS provides tax inflation adjustments for tax year 2024” https://www.irs.gov/newsroom/irs-provides-tax-inflation-adjustments-for-tax-year-2024 Accessed November 29, 2023
4 IBID – IRS provides tax inflation adjustments for tax year 2024 https://www.irs.gov/newsroom/irs-provides-tax-inflation-adjustments-for-tax-year-2024 Accessed November 29, 2023
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Interest on municipal bonds is generally exempt from federal income tax; however, some bonds may be subject to the alternative minimum tax (AMT). Typically, state tax-exemption applies if securities are issued within one’s state of residence and, if applicable, local tax-exemption applies if securities are issued within one’s city of residence. The tax-exempt status of municipal securities may be changed by legislative process, which could affect their value and marketability.
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