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The 5 Most Tax-Efficient Investments For Your Portfolio

Posted by Jim Kantowski, CFP®, CPA on July 23, 2020

The 5 Most Tax-Efficient Investments For Your Portfolio

You want to hold onto as much of your wealth as possible—but you know that’s easier said than done, especially when it comes to taxes. One way to save money at tax time that doesn’t require you to constantly track your expenses is by using tax-efficient investments.

A tax-efficient approach helps minimize the amount of tax you pay on your savings and investments, and it’s an integral part of your financial plan. The most important thing to remember about tax-efficient investments is that there are many options, and some may be more suited to your situation than others—so be thoughtful about where you’re putting your money. (Tweet this!)

In this article, we’ll walk through the five tax-advantaged savings accounts so you can choose which wealth management options are the best fit for you.

Want to create a financial plan that helps you save as much as possible at tax time? Schedule a call with a Bay Point Wealth advisor today to get started.

The Most Tax-Efficient Investment Accounts: 5 To Consider

Investing in tax-advantaged accounts is an excellent way to grow your wealth. These types of accounts provide various tax benefits, which we’ll cover below. While some accounts allow you to defer tax on the money you invest until you withdraw it, others require you to pay tax on the money you put in up front—but offer tax-free growth on the money you take out. We’ll identify which of the five most tax-efficient investments offer upfront tax deferrals or tax-free growth as we run through the list. Let’s get started!

1. Employer-Matched 401(k)

Many employers provide this type of retirement plan, which enables you to contribute a portion of your pre or post-tax income. Your employer will then match a certain amount of your contributions (the national average is slightly over 4%).

One significant benefit of a 401(k) plan is that you can invest a greater amount of your earnings into this account than you can put into an individual retirement account (IRA) or a Roth IRA, which we’ll explore next. People in the workforce under 50 years old may contribute up to $19,500 per year to their 401(k), while those over 50 may put an additional $6,500 into their account annually.

At minimum you should contribute the amount that is matched by your employer—it is free money!

2. Individual Retirement Account (IRA)

If your employer doesn’t offer a 401(k) plan, an IRA is one of the most tax efficient investment accounts you can choose. This type of account allows you to take a deduction for your contribution (as long as you meet certain income restrictions) and defer tax on the money you initially deposit.

Your IRA can hold stocks and bonds. It’s a great fit if your tax rate is likely to be higher when you fund the account than it will be when you make a withdrawal—which is when you’ll be taxed on your previous contributions. You must begin taking money out of your IRA when you reach age 72, but you can start as early as age 59 if you like.

3. Roth IRA

A Roth IRA is an account that enables your investments to grow tax-free. In contrast to a traditional IRA, you pay tax upfront when you invest in this type of account.

You’ll realize the benefits of a Roth IRA later down the road when you want to withdraw your money, because you won’t pay tax on it at that time. This is especially helpful if you’re in a higher tax bracket when you withdraw the funds than you were when you opened the account. If you’re considering this type of account, keep in mind that Roth IRAs have various income limits.

4. Health Savings Account (HSA)

If you have a health insurance plan with a high deductible, you’re eligible to open an HSA. Individuals can put up to $3,550 into their HSA, while families can contribute up to $7,100. The catch here is that the money must be used for medical expenses or Medicare premiums. The main benefit of an HSA is that any money you take out is tax-free.

Pro tip: Many people invest in their HSA, let the wealth in the account grow until retirement, and use the money then to cover medical expenses and Medicare premiums (HSA accounts are generally not allowed to be used for health insurance premiums). You receive a tax deduction up front and the money comes out tax-free, to be used for medical expenses or Medicare premiums. Those 50 and older can contribute an additional $1,000.

5. 529 Account

A 529 account is one of the most tax-efficient investments available if you’re planning to save up for your children’s education or transfer wealth to future generations.

Similar to a Roth IRA, this type of account grows tax-free. However, a 529 account doesn't carry an annual contribution limit, though it's recommended you follow the annual gift tax limits. In contrast, a Roth IRA only allows you to put $6,000 into the account each year (or $7,000 if you're over 50). If you’re saving for college, you’ll have a larger window to increase your wealth than if you’re saving for elementary or secondary school. 529 contributions are still owned by the Account Holder and can be accessed if needed. In addition, you can change beneficiaries if one (or more) of your children choose not to go to college, or receive a scholarship.

Diversify Your Investments in Tax-Favored Accounts

It’s wise to choose several types of tax-efficient accounts to broaden your portfolio, so you’ll have greater flexibility to decide which account to withdraw money from, and when, to reduce your tax bill.

In addition to having various types of accounts, strive to include different kinds of investments in each account. This strategy is often referred to as asset location. For example, it’s a good idea to keep regular bonds (which carry a higher interest rate) in your IRA to defer tax on those investments.

Giving to charity is another way to diversify your portfolio and minimize the amount you owe on your tax return. For example, if you’re a business owner and you sell your company for $1 million then decide to give $100,000 to charity, you can take the entire charitable tax deduction in the year you sell the business, but you don’t have to choose where to donate the money until later. Using a donor-advised fund allows you to invest the money and choose the charity in the future.

Work With A Trusted Advisor

At Bay Point Wealth, we know taxes. Our advisors go beyond buying and selling mutual funds. We try to find opportunities to help you save money and realize greater value from your investments. We can recommend the most tax-efficient investments for your personal financial situation, and advise you on the best time to make withdrawals.

We also look at your bigger financial picture, integrating your tax plan with your overall financial plan to help you reach your goals faster.

If you’re interested in learning more about tax-efficient investments, schedule a free consultation call with one of our expert advisors at Bay Point Wealth today.

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Topics: Investment News, Wealth Management