Smart Ways to Invest for Tax Efficient Returns

Everyone has questions about money.  Give us two minutes and we’ll see if we can answer yours.  Mike McCormick is a Registered Investment Advisor in Bozeman, Montana. His clients have complicated financial lives that are put in perfect order and kept that way. The information in this podcast is for informational purposes only and cannot be construed as financial advice.

Thank you Natalie. Have you ever wondered how much you’re going to pay in taxes over the course of your entire life? Not a happy thought, I know. But it could add up to more than $1.4 million if you’re making an average of $100,000 a year. And that’s just federal taxes!  That is brutal. Want to get angry about it? Well, a 2016 study identified that four out of 10 households in America pay no federal tax at all. 0. And millionaires and billionaires not paying taxes frequently makes the headlines. The reality is, is that the lion’s share of federal income taxes are paid by those who are in the higher income brackets. And rather than getting mad, let’s get smart. There’s things you can do to manage your tax liability and save perhaps as much as 10%, which is significant when you’re looking at $1.4 million. 

There’s a few key principles I’d like to go over:

• Use a good CPA. Your accountant is the doctor on this one. I’m not a tax advisor. I do know how to make investments work well with tax liability of high income earners, but it’s your accountant that will have the final ruling. And while we do not provide tax advice, here’s what we do suggest. 
• Be smart about using your retirement accounts. You do of course want to maximize them to the ability that you’re able to. During your low income years go after the Roth, but it’s in your high income years that you really want to get that tax deferral maximum as soon as you can. 

Outside of retirement accounts, investing for tax efficiency becomes more difficult and more nuanced. There’s three strategies that we have in mind to help keep it simple. 

• 1st. This sort of money we’re talking about is for investing, not gambling. Nothing that you intend to buy and sell in a year is appropriate for this money. Why? Well, first of all, it’s speculative. This is liquid funds that you need to have accessible for business opportunities or emergencies. 
• Secondly, No short term trading in under a year.  Whether it’s real estate, gold, Bitcoin, or stocks, your taxes will come to you as short term income. You may even be paying the highest rate of taxation on any gains that you make. There’s great examples of people making big amounts of money doing short-term penny stock trades or doing options. Here’s the reality. What they keep after taxes is sometimes on par with investing in something boring like Procter and Gamble.  Long term investing means that you’re prepared to ride through the tough time and not sell. So this means that by definition, this is more conservative money. Do your aggressive investing in your retirement accounts, but these funds, like I said earlier, we want to keep him liquid. We want to keep them available. Your biggest income earner is you. Let’s not take short term risks if things go well. If you hold the investment over a year, you’ll get long term capital gains. That could be potentially half the tax rate of a short term trade. 
• Last, please steer away from mutual funds. Mutual funds have this really frustrating feature where it’s the managers of the fund that choose when you bear the tax burden of participating. This is tax inefficient and usually comes at the worst possible times. If you want to have mutual funds, put him in your retirement accounts. Don’t let them monkey with your tax liability. 

Next up trusts. If you have a trust, great, just understand how it’s taxed. The tax rates for trusts can be significantly higher than the tax rates are for you personally. You want to be prudent about handling the income and gains, and perhaps distributing them to you individually before year end. Definitely consult your tax advisor on that one. 

Lastly, give away money smart. I have another podcast about prudent charitable giving. There’s great charitable programs out there, but first of all, recognize that you probably own something that has a tax liability. The nonprofit doesn’t feel the tax liability, but you do. They don’t care. Give him the stock. It’s easy to do. Talk to your advisor on how to do it. 

Thanks a lot for listening. Important thing is recognizing that it’s not what you make, it’s what you keep.

Thank you for turning into the Montana money minute. If you’ve got a question for us, send me an email. I also appreciate any feedback. Have a great day and remember to go easy on yourself. Life’s hard. Let’s make the money part as easy as possible.