Most of us know how important it is to save and invest for our future. Those who are experienced investors also understand that asset allocation—having a proper mix of different stocks, bonds and cash—can balance risks against rewards.
Few people, however, fully understand the importance of asset location.
WHEN IT COMES TO TAX-INVESTMENT PLANNING, IT'S ABOUT LOCATION, LOCATION, LOCATION
Asset location is fundamental in tax-efficient investing. Not all investments are taxed equally. Some investments, like the dividends from Hawaii municipal bonds, for example, are exempt from federal and state taxes if you are a Hawaii resident. Other dividends, called “qualified dividends," are subject to lower tax rates, while still other investments can grow tax-deferred and are taxed when the money is withdrawn at the eligible age.
Know the difference between taxable and tax deferred investment accounts. You'll want to use taxable accounts for buying and holding investment and municipal bonds and stocks, and tax deferred accounts (such as an IRA) if you do active trading (Of course, IRAs can provide benefits even if you're not actively trading).
Importantly, selecting the proper retirement account for your nest egg can have significant tax ramifications later in life.
THERE ARE TAX CONSEQUENCES WHEN SELLING INVESTMENTS OR WITHDRAWING MONEY
Many executives are compensated with additional benefits such as deferred compensation or stock options. After you’ve addressed some of the dangers above and find that you haven’t saved enough, you could possibly use some of these benefits to bridge the gap once you retire. Or if you’ve done a great job of saving throughout your career, you can work with your advisor to understand the tax implications of how and when you exercise your options. Some options may require elections to be made a year prior to retirement; it is imperative that you understand the policies of your company. These will be crucial to align the timing and investment vehicles with your cash flow analysis.
SEEK AN ADVISOR WITH EXPERIENCE IN PLANNING FOR EXECUTIVES
Remember: It's not how much money your investment makes, but how much of the taxable money you keep after taxes are applied.
A tax efficient investment strategy that maximizes your returns will include several different taxable and non-taxable accounts. Depending on your age and tax bracket, funds are placed in the appropriate investment accounts that may provide higher after-tax returns. For retirees, it is just as important to know how much to draw for income as it is to know which accounts to draw from.
DID YOU KNOW YOU COULD END UP PAYING TAXES ON AN INVESTMENT THAT LOST MONEY?
In addition to knowing where to place your funds, understanding the tax consequences of each type of investment is also important. A mutual fund that has a high portfolio turnover, for example, could create a tax bill at the end of the year, even if that mutual fund lost money!
The bottom line is, if you are in a higher income tax bracket or are retiring soon, you owe it to yourself to discuss tax efficient investing with a knowledgeable financial adviser. Also, consult a tax adviser who can develop a tax efficient strategy based on your individual situation.
Bank of Hawaii does not provide tax, legal or accounting advice. This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, tax, legal or accounting advice. You should consult your own tax, legal and accounting advisers before engaging in any transaction.
Neither the information nor any opinions expressed herein should be construed as a solicitation or a recommendation by Bankoh Investment Services or its affiliates to buy or sell any securities, investments or insurance products. The views and strategies described herein may not be suitable for all investors. Investing involves market risk, including possible loss of principal, and there is no guarantee that investment objectives will be achieved.