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How to be a tax-aware investor

Thoughtful decisions about the asset classes you choose and the accounts you hold them in could help you lower your tax bill.


TAXES AREN’T A ONCE-AND-DONE THING. There are plenty of steps, beyond the last-minute rush to file every April, that investors can take to help reduce their tax liability, says Vinay Navani of the accounting firm WilkinGuttenplan P.C.* In fact, he adds, “It’s crucial to make tax considerations an integral part of every investment decision, all year round.”


And you don’t have to go it alone. Your financial advisor can help you make critical decisions related to the timing of the purchase or sale of stocks, the asset classes you choose, whether you hold them in tax-deferred or taxable accounts and the order in which you draw down your assets — all of which could potentially help to lower your tax bill and increase your overall return on investment.


Asking your advisor the following five questions could help you minimize the tax impact on your returns.

Infographic titled "Want to Be a Tax-Smart Investor? Consider These 5 Tips." For full details, visit the link below.

1. What asset classes should I consider owning?

Before you decide on the percentage of stocks, bonds and cash instruments that make the most sense for you, it’s helpful to understand how the IRS treats the income from those asset classes. Ordinary income, including from interest payments on bonds and cash, is currently taxed at individual rates as high as 37%, plus a potential additional 3.8% if the net investment income tax applies. Profits from the sale of stocks you’ve held for more than a year qualify as long-term capital gains, and the long-term capital gains tax rate currently maxes out at 20%, plus the potential 3.8% net investment income tax may apply. (It’s worth noting that future tax law changes are always a possibility.) Also, be aware that if you hold a stock a year or less and sell it at a profit, the gain will be taxed at your ordinary income rate, which could be considerably more than the capital gains rate.


2. Should I invest in a tax-deferred or taxable account?

“Your advisor can help you think through the tax implications of where you hold different types of investments,” Navani says. For instance, investment income from assets held within a 401(k) or traditional IRA generally isn’t subject to taxes until you withdraw it. For that reason, you may want to place holdings that generate ordinary income — bonds or non-qualified dividend-producing stocks — in tax-deferred retirement plan accounts. Withdrawals you take during retirement may be taxed at your ordinary income rate, which may be lower at that time.  Your tax advisor can also help you determine if certain circumstances apply to you that may make an account funded with post-tax dollars - including a Roth account - a better option for investments that generate ordinary income.


By contrast, it’s often smart to hold non-income-producing assets, such as growth stocks, in taxable accounts. Even if they increase substantially in value, you generally won’t experience any tax consequences until you sell them.


Another exception: municipal bonds, which are generally exempt from federal (and, in some cases, state and local) taxes, notes Navani. Be aware, he adds, that tax-exempt bond income is usually tax-exempt when it’s held directly, but when it’s distributed from a retirement account — unless it is a qualified distribution from a Roth account, generally — it’s treated as ordinary income and is taxable. Ask your advisor whether municipal bonds, which often have a lower yield than other bond options, may be an appropriate choice for your non-retirement account portfolio.


“It’s crucial to make tax considerations an integral part of every investment decision, all year round.”

— Vinay Navani, CPA and shareholder, WilkinGuttenplan P.C.

3. When should I begin taking withdrawals in retirement?

It’s often wise to leave as much as you can in your retirement accounts as long as you can, so those investments can have the potential to grow on a tax-deferred basis. As long as you’re working, you generally don’t need to take required minimum distributions (RMDs) from your qualified retirement plan, such as a 401(k). Thanks to the SECURE 2.0 Act, which was signed into law in December 2022, you don’t have to take your first RMDs from a qualified retirement plan until April 1 of the year after you reach 73 (or 72 if you turned that age in 2022).  Regardless of whether you are still working, you will need to take your first RMDs from a traditional IRA at age 73 if you turn 72 after December 31, 2022.1


If you need additional money beyond RMDs to meet living expenses, your advisor can help you review other possible sources, such as cash or assets in taxable accounts, that may be preferable to tap to avoid depleting your retirement accounts. Then, you can make any necessary adjustments to your portfolio, keeping the tax implications in mind.


4. How can I make tax-efficient donations?

Changes made to the tax law in 2017 may have curtailed your ability to deduct charitable donations from your taxes. However, by donating appreciated shares of stock directly to charity, you can avoid the capital gains taxes that would apply if you sold the stock first and then donated the proceeds. The deduction for long-term capital gain assets is equal to the stock’s fair market value. Otherwise, the deduction for a short-term gain is limited to the lower of either fair market value or basis. Your tax advisor can help you consider whether donating appreciated stock makes sense for you.


If you’re retired and are at least age 70½ and don’t need all of your RMDs for living expenses, you could donate assets directly from your traditional IRA to a qualified charity in the form of a qualified charitable distribution (QCD), thereby satisfying all or a portion of your RMD and potentially reducing your taxable income. You can make QCDs of up to $100,000 annually, Navani says, and that limit will be adjusted for inflation starting in 2024. Beginning in 2023, you also have the option to make a one-time transfer of up to $50,000 of your QCD into certain types of charitable trusts and charitable gift annuities. QCDs are subject to additional rules and limitations. Your tax advisor can help you understand the requirements for a QCD and consider whether making one could help you lower your taxable income.


5. What tax implications do I need to consider before buying and selling assets?

“Your advisor can help you think through the tax implications of where you hold different types of investments.”

— Vinay Navani, CPA and shareholder, WilkinGuttenplan P.C.

In a good year, you may want to lock in gains by strategically selling appreciated assets. “But try to avoid selling stocks you’ve held a year or less, since they’ll be taxed at your individual rate for ordinary income, while you’ll pay no more than a 20% tax on long-term investments,” Navani says.2


When you sell, you may be able to take advantage of tax-loss harvesting, or selling investments that have dropped in value in order to offset taxable gains. You can generally deduct up to $3,000 (or $1,500 if married and filing separately) of capital losses in excess of capital gains per year from your ordinary income. And if your net capital losses exceed that yearly limit, you can carry over the unused capital losses to the following year.


Your advisor can look for opportunities to do this throughout the year. Bear in mind that if you buy substantially identical stocks within 30 days before or after the sale, it will be considered a “wash sale,” and you may not be allowed to subtract those losses.


Finally, buying or selling assets solely to avoid taxes could be counterproductive. When the market is strong, you might look at taxes as a necessary cost of capturing substantial capital gains, Navani says. By contrast, by holding on to assets for fear of taxes, you could lose out if those assets later drop in value.


All the more reason to work with your advisor to think through every consideration about your life and financial goals — not just the tax implications — as you make your investment decisions.

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* As a CPA and shareholder at WilkinGuttenplan P.C., Mr. Navani is not affiliated with Merrill. Opinions provided are his, do not necessarily reflect those of Merrill, and may be subject to change. Merrill, its affiliates and financial advisors do not provide legal, tax or accounting advice. You should consult your legal and/or tax advisors before making any financial decisions.


1 Individuals generally must begin taking RMDs from their non-Roth qualified retirement plan accounts by April 1 of the year following the later of the calendar year in which they reach the required age (73 or 72, as applicable) or retire. If the individual’s retirement plan account is an IRA, they must begin taking RMDs by the required age, regardless of whether they are still employed.


2 A 3.8% net investment income tax may also apply.


Merrill, its affiliates, and financial advisors do not provide legal, tax, or accounting advice. You should consult your legal and/or tax advisors before making any financial decisions.



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