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Tom Limoges

April 10 , 2017

An Often Overlooked Strategy – Tax Diversification

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Portfolio diversification among asset classes is one of the fundamentals of our investment management philosophy. Over time, a portfolio built with a variety of investments should provide a better risk-adjusted return than any one individual investment within the portfolio. Diversification can also be applied with regard to tax planning. Given the uncertainty of future taxes, diversification among savings vehicles along with a focus on asset location can provide a solution.  

For savings purposes, there are a variety of types of accounts to consider. From tax deferred to Roth and even taxable accounts, each type has a different and unique treatment from a tax standpoint. By investing in multiple account types, investors can have more flexibility when planning for taxes and drawdown of your resources in retirement. Taking into consideration asset location, certain asset classes and investment types are a better fit from a tax standpoint in specific types of accounts:

 

Tax Deferred Accounts

Traditional IRA’s and 401(k) accounts are excellent account types to allocate taxable income producing assets such as bonds and bond funds. This strategy can reduce current tax liabilities by lowering taxable income.  Along with reducing portfolio volatility, these types of investments traditionally carry lower growth rates when compared to equities – allowing Roth and Taxable accounts to grow at a higher rate if invested in risk oriented assets.

 

Roth Accounts 

At normal retirement age, distributions from Roth accounts are tax free. In addition, Required Minimum distribution (RMD) rules do not apply to Roth accounts. These Roth account attributes make growth-oriented equity investments a good choice. Actively managed, domestic and International stock mutual funds are a good option for Roth accounts as capital gains are contained within the account and not taxed to the individual.

 

Taxable Accounts

Income and capital gains earned in this type of account have an impact on taxes owed in the year they are incurred. Tax free income sources such as tax except bonds work well in these types of accounts. Passively managed (index) mutual funds or exchange traded funds (ETFs) as well as a diversified portfolio of common stocks managed in a way to reduce capital gains should warrant consideration in taxable accounts. Tax loss harvesting with the above investments can also play a role in the management of taxable accounts.      

We believe that tax management should play a role in the portfolio construction process, but it is not the only consideration. Risk tolerance, goals, and time horizon are also reviewed when creating a portfolio for our clients. At Security National Bank, we realize that each situation is different and work with each client to ensure those unique goals are met. Thank you for your continued support and for those late filers, Tax Day 2017 is a week away.   

 

To speak more with one of Security National Bank's Wealth Management Team, click below.

 

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