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Tax Optimization

6 Tax Strategies That Will Have You Planning Ahead

Here are six tax tips you can follow now to help save money on your taxes in 2017—and years to come.

Articles by Nick Holeman, CFP®

By Nick Holeman, CFP®
Financial Planning Expert, Betterment
Published: December 21, 2016 | Updated: April 23, 2019

While most people only think about taxes in April, you can take steps year-round to minimize your taxes.

Strategies like Roth IRA conversions and tax loss harvesting can be most effective when done in the beginning of the year, instead of waiting until the end.

Placing tax-inefficient investments in retirement accounts can shelter dividends throughout the year and reduce your taxes even more.

Most people tend to think about taxes just once a year—usually March or April. But investors can save more in taxes each year by thinking ahead and strategizing about their taxes on an ongoing basis.

Today, savvy investors aren’t beating the market day-to-day; instead, they’re focused on taking home more of their earnings by lowering taxes and fees across their portfolio.

That means thinking about all of your tax-advantaged options—accounts you have now and selections you’ll make in the future—to make every move as tax-efficient as possible. You can think of accounts like IRAs, 401(k)s, 529 accounts, and HSAs as unique opportunities that if implemented strategically, can help you earn more over time.
In this article, we’ll introduce six tax strategies that require ongoing planning, but if taken into consideration, can help you keep more of what you earn.

1. Shelter dividends in retirement accounts.

By reorganizing your investments, you can shelter many dividends from being taxed. This strategy, called asset location, can not only reduce your annual tax bill, but also help to increase your after-tax investment returns by an average of 0.48% per year. Over 30 years, this can amount to around 15% in additional after-tax returns.

At Betterment, we have a service called Tax-Coordinated Portfolio™ that does this automatically. It works by placing investments that are taxed more into traditional and Roth IRA accounts, which have big tax advantages. It places investments that are taxed less, such as municipal bonds, in your taxable accounts.

This is a great way you can use your current investments to help reduce your taxes. Here’s a simple animation solely for illustrative purposes:

Asset Location in Action


2. Start tax loss harvesting earlier.

Another way to use your investments to help reduce your taxes is through tax loss harvesting (learn how to do it automatically with Betterment’s Tax Loss Harvesting+).

By selling investments at a loss, you can generate a tax deduction. You can use this deduction to offset other investment gains you earned during the year, or even to decrease your taxable income by up to $3,000.

Most investors only view tax loss harvesting as a year-end strategy to get some last-minute deductions, and thus won’t be able to benefit from any other losses throughout the year.

A better strategy to consider is monitoring your portfolio throughout the entire year for opportunities to harvest losses. This is especially effective if you are in a high tax bracket or have large capital gains this year.

3. Contribute earlier to retirement accounts.

It’s true that you have until each year’s tax filing date to contribute to your IRA for the previous year. However, if you’ve already maxed out your the previous year’s IRA contributions, consider maxing out this year’s IRA contributions as early in the year as possible—this can give you up to 15 extra months (January of this year to April of next year) in the market.

Waiting until the last minute could cost you more than you think. In fact, funding your IRA in January has historically resulted in an extra $14,507 over any 10-year period since 1928.

So if you still haven’t funded your IRA for last year, consider doing it now instead of waiting until mid-April.

4. Execute Roth conversions in January, not December.

A Roth conversion moves money from your traditional IRA to your Roth IRA and is sometimes referred to as a backdoor Roth IRA conversion,. You may pay taxes when converting, but once inside your Roth IRA, future earnings and qualified withdrawals will be tax-free.

You can convert your IRA at any point throughout the year, but most people wait until the last minute. Similar to procrastinating on your retirement account contributions, by waiting until December to convert, you’ll miss out on 11 months of potential tax-free growth.

If you’re worried about converting in January because you don’t have a clear enough picture of what your taxes for the year will look like, you can undo your conversion. The technical term for this is a “recharacterization.” The tax code allows you to recharacterize all or a portion of your Roth conversion up until October of the next year.

The ability to recharacterize Roth IRA conversions is a nice benefit allowed by the IRS, so consider doing your conversions early in the year to help maximize your tax-free growth.

Note: This information is for educational purposes only and is not a substitute for the advice of a qualified tax advisor. Roth conversions can have significant tax implications and you should consult a tax professional to discuss any questions about your personal situation and whether a Roth conversion is right for you.

5. Put your tax refund to good use.

If you’re like 73% of Americans, you receive a tax refund averaging $2,800.

That refund may sound great, but really that means, in this example, that you overpaid your taxes each month by $233. That is money that could have been invested and growing for you throughout the year.

To adjust how much money is withheld from each paycheck for taxes for the following year, you could consider resubmitting your Form W-4 to your employer. Making the change early in the year will allow it to take full effect, and filling it out properly can ensure the correct amount is taken out.

Then, consider putting that money to work.

After adjusting your W-4, consider increasing your 401(k) contribution by that same amount. You won’t notice a difference in your paycheck, and that money will go toward your retirement instead of loaning it to the IRS.

6. Make tax-smart investment switches.

You can likely benefit from reviewing your investment portfolio, but it’s important to minimize the tax consequences of making any adjustments.

Rebalance your portfolio tax-efficiently.

One example of a change you might consider is rebalancing your portfolio. Here’s how it works: As markets move up and down, your portfolio can drift away from its target allocation. Rebalancing allows you to realign the weight of stocks and bonds so that your asset allocation is appropriate for your goal’s time horizon.

However, rebalancing by selling existing investments should generally be a last resort because this can cost you in taxes. Instead, consider using cash flows to rebalance; use new deposits, dividends you earn, and proceeds from tax loss harvesting to rebalance your portfolio on an ongoing basis. This will minimize the need to sell investments and thus can help reduce your taxes.

At Betterment, we automate this entire process to help keep your portfolio properly balanced with every cash flow.

Get out of high-cost investments.

Another tax-smart change you might consider is getting out of high-cost investments. Look for losses you can use to offset any gains associated with swapping a high-cost fund for a low-cost one.

Even if switching out of the high-cost fund will cause you taxes, consider doing a breakeven analysis to see if it still makes sense. For example, if selling a fund will cost you $1,000 in taxes, but you will save $500/year in fees, you can break even in just two years. If you plan to be invested for longer than that, it can still be a savvy investment move.

Our calculator can help you with this decision.

Rebalancing and reducing fees are both important, but make sure you don’t ignore taxes while executing these strategies.

Wrapping It All Up

We all talk about tax season, but really, taxes are a topic we should think about throughout the year as we invest our savings.

  • Sheltering your tax-inefficient investments in your retirement accounts can reduce dividend taxes and help keep more money in your pocket.
  • Tax loss harvesting throughout the year, not just in December, can reduce your taxes and help increase your after-tax investment returns.
  • Retirement contributions and conversions done early in the year are more effective because they allow your investments to grow for longer.
  • Correcting your tax withholdings can allow you to save more throughout the year, instead of having to wait for your tax refund.
  • Lastly, don’t ignore possible taxe implications while rebalancing or adjusting your investment portfolio.

Together, these strategies may significantly reduce your tax bill. And by automating them by using a service like Betterment, you can take advantage of these strategies without adding stress during tax season.

Betterment is not a tax advisor, nor should any information in this article be considered tax advice. Please consult a tax professional.

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