Why tax-conscious investing matters.

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     No investment or financial decision exists in a vacuum - every such decision has a tax, long-term investment growth, retirement, and\or estate planning impact, many of which will not even be noticeable until many years have passed.  Even then, the connection between that result and yesterday's action - or more commonly, inaction - will only rarely be realized. Although the landscape of tax, investment, and Social Security-related regulations, statutes, and laws provides an ever-shifting, unpredictable backdrop against which investment and financial planning decisions must be evaluated today and reevaluated tomorrow, this article is intended to highlight the importance of developing greater "tax-consciousness" when considering investment, retirement, financial planning, and even estate planning decisions.

1. Are my investments being allocated in a tax-efficient manner among IRA, 401(k), Roth, and taxable accounts?
The potential tax benefits of "asset location" are often overlooked by investors.  As a general rule, stocks and qualified dividends receive favorable tax treatment in a taxable account, as well as a potential "step-up" in basis, but receive none of these benefits in a tax-deferred IRA or 401(k) account. Roth IRAs are often ideal for those assets within one's overall portfolio that have the highest long-term growth potential. Taxable bond interest is usually highly "tax-inefficient" when placed in a taxable account and is therefore usually most suited for an IRA account, where the ordinary interest income can grow on a tax-deferred basis.  Similarly, income from  REIT's, trust deeds, and cash typically generate ordinary income taxed at one’s marginal rate, and are therefore usually most suited for tax-deferred IRA accounts not only for that reason but also because much of their total return is typically in the form of income generation, not capital growth.  As a result, there is less likelihood of these investments benefiting from the stepped-up basis available in a taxable account.

2. Are opportunities to lock in capital gains in a tax-efficient manner being explored annually?
Harvesting of capital gains in low or zero-tax years is often overlooked. For example, married couples who have taxable income under $74,900 during the 2015 tax year may wish to take advantage of the zero percent long-term capital gains tax rate below that income level and obtain a “free” step-up in basis for at least a portion of their long-term capital gains.  This would be particularly compelling if the investment was going to be sold at a future point where capital gains would be paid.  Of course, it the client was planning on keeping the investment until death, when the stepped-up basis could be obtained, then any capital gains due on sale would be a moot point.

3. Is my marginal tax bracket being looked at every year in order to determine the priority of account I should be contributing to?  One’s marginal tax bracket is a major factor that determines the priority of contributing to a tax-deferred IRA or 401(k), a Roth, a taxable account, a 529 savings plan, or other account. Because of the significant benefit gained from deferring taxes, contributing to deductible, tax-deferred accounts is often the top priority for those in higher marginal tax brackets, especially if one's marginal tax rate is anticipated to be lower during retirement, as is typical.  Investors in lower marginal tax brackets gain little benefit from making contributions to tax-deferred accounts unless they are receiving a matching contribution. Of course, a Roth account would be the first choice is such situations, at least up to the point where the maximum contribution is reached.  Depending on the owner’s ability to “tax-manage” a taxable account with low-turnover equity index funds, a taxable account contribution can often be far more beneficial than a tax-deferred, non-matching contribution to a retirement account for one who is in a low or zero marginal tax bracket.