Even investors who spend a lot of time thinking about how to maximize their portfolios for performance may lack a strategy when it comes to taxes on those returns.
The comprehensive tax reform that passed in 2017 may mean that you’re seeing higher take-home pay, but because the law removed certain itemized deductions and put a cap on others, you may face a higher federal tax bill.
Applying an active tax-management strategy for your investments may be one way to help reduce your overall tax burden.
Even small reductions in tax payments today can have a big impact on your wealth tomorrow. Consider putting in place some or all of the following potential solutions.
Use Tax-Aware Asset Location
Different kinds of accounts are taxed differently. A tax-aware asset location strategy that accounts for those differences may increase your after-tax returns. For example, by allocating higher-yield assets, such as high-dividend-paying stocks, to tax-deferred and tax-exempt accounts, such as Individual Retirement Accounts, you can help minimize your exposure to current taxes. Your Financial Advisor can assist you or your tax advisor in structuring a tax-aware asset location strategy across your accounts.
Consider Tax-Favorable Investment Solutions
Many investments allow you to save for a variety of goals while also offering tax benefits. Municipal bonds, which are typically exempt from federal (and in many cases, state and local) taxes, can be a tax-efficient investment against current and potentially higher tax rates. Beyond municipal bonds, consider tax-efficient mutual funds or separately managed accounts that aim to limit the number of taxable events within your portfolio.
If you’re saving to cover future education costs, a 529 savings plan is a tax-advantaged way to save for educational expenses, such as college tuition. As of 2018, you can also withdraw funds from a 529 to pay tuition for a K-12 school. The change, included in the 2017 tax law, limits qualified 529 withdrawals for K-12 tuition to $10,000 per beneficiary per year.
Many states are also extending 529 plan state-tax benefits, including receiving state income-tax deductions for contributions and withdrawing funds state-tax-free, when they are used for K-12 tuition.
The 2017 tax law limited itemized deductions, making it harder for taxpayers to exceed the standard deduction. However, donating through a donor advised fund can help you aggregate your charitable contributions, allowing you to exceed the standard deduction. Because a donor advised fund is maintained and operated by a public charity, you’ll receive the full tax benefit when you contribute to the fund, up to the per-year charitable contribution limit, and you can distribute the funds to your favorite causes over time.
For retirement savers, diversifying your retirement portfolio with a variable annuity may provide tax-deferred growth potential, guaranteed lifetime income, increased retirement savings, equity upside potential, and a death benefit for named beneficiaries.
Employ Tax-Loss Harvesting
Current U.S. tax law permits tax-loss harvesting, a process by which you can offset capital gains with capital losses that you’ve incurred during that tax year, or carried over from a prior tax year, which could lower your tax bill. Capital gains are generally the profits you realize when you sell an investment for more than you paid for it, and capital losses are generally the losses you realize when you sell an investment for less than you paid for it. If your losses exceed your gains, they can be used to offset up to $3,000 of ordinary income each year. Any additional excess capital losses can be carried forward as potential tax offsets.
When engaging in tax-loss harvesting, be sure you don’t inadvertently participate in a “wash sale,” which can occur when you sell or trade stock or other securities at a loss, then buy substantially identical stock or other securities within 30 days before or after the sale. Talk to your Financial Advisor to learn about your options.
Max Out Retirement Plans
If your tax burden is rising, consider fully funding your employer-sponsored retirement plan, such as your 401(k), since contributions can be made on a pretax basis. Contributing to a Traditional IRA can also lower your tax bill, since contributions may be tax-deductible. Because these are tax-deferred accounts, you generally won’t pay income taxes on contributions, or any earnings from your investments, until you withdraw funds. For 2019, you can contribute up to $19,000 to your 401(k) plan, or $6,000 into your Traditional IRA; savers 50 and over can contribute up to an additional $6,000 and $1,000, respectively.
Engage in Legacy Planning and Gifting
For 2019, the federal estate tax exemption increased to $11.4 million per individual. Regardless of whether you will generate estate taxes, all investors should have an estate plan that reflects their wealth-transfer goals and objectives. Trusts can be an effective tool to reduce estate taxes, or assure a fair distribution of wealth among family members. Taxpayers with taxable, or potentially taxable, estates who would like to leave money to their heirs should consider making lifetime gifts to those heirs now. This can also be a tax-efficient wealth-transfer strategy because it removes any future appreciation in the gift’s value from the client’s taxable estate. Also, consider making gifts under the annual gift tax exclusion ($15,000 for 2019) to individuals and charitable gifts before year-end. Morgan Stanley’s Donor Advised Fund may be a good solution to help you achieve your charitable giving strategy.
These investment strategies can help minimize your overall tax bill. Contact your tax advisor and Financial Advisor on which strategies might be appropriate for you.
This material does not provide individually tailored investment advice. It has been prepared without regard to the individual financial circumstances and objectives of persons who receive it. The securities discussed in this material may not be suitable for all investors. Morgan Stanley Wealth Management (“Morgan Stanley”) recommends that investors independently evaluate particular investments and strategies, and encourages investors to seek the advice of a financial advisor. The appropriateness of a particular investment or strategy will depend on an investor’s individual circumstances and objectives.
Tax laws are complex and subject to change. Morgan Stanley Smith Barney LLC (“Morgan Stanley”), its affiliates and Morgan Stanley Financial Advisors and Private Wealth Advisors do not provide tax or legal advice and are not “fiduciaries” (under ERISA, the Internal Revenue Code or otherwise) with respect to the services or activities described herein except as otherwise provided in writing by Morgan Stanley and/or as described at www.morganstanley.com/disclosures/dol. Individuals are encouraged to consult their tax and legal advisors (a) before establishing a retirement plan or account, and (b) regarding any potential tax, ERISA and related consequences of any investments made under such plan or account.
Asset allocation and diversification do not assure a profit or protect against loss in declining financial markets.
Interest on municipal bonds is generally exempt from federal income tax; however, some bonds may be subject to the alternative minimum tax (AMT). Typically, state tax-exemption applies if securities are issued within one’s state of residence and, if applicable, local tax-exemption applies if securities are issued within one’s city of residence. The tax-exempt status of municipal securities may be changed by legislative process, which could affect their value and marketability.
Mutual funds and variable annuities are sold by prospectus. The prospectus contains the investment objectives, risks, fees, charges and expenses, and other information regarding the mutual fund or variable annuity contract and its underlying investments, which should be considered carefully before investing. Prospectuses for the mutual fund or the variable annuity contract and its underlying investments are available from your Financial Advisor. Please read the prospectus carefully before investing.
Variable annuities are long-term investments designed for retirement purposes and may be subject to market fluctuations, investment risk and possible loss of principal.
All variable annuity guarantees, including optional benefits, are based on the financial strength and claims-paying ability of the issuing insurance company and do not apply to the underlying investment options.
Variable annuities are offered in conjunction with Morgan Stanley’s licensed insurance agency affiliates.
The 529 Plan Program Disclosure contains more information on investment options, risk factors, fees and expenses, and potential tax consequences. Investors can obtain a 529 Plan Program Disclosure from their Financial Advisor and should read it carefully before investing.
This $10,000 529 per year withdrawal limit applies in the aggregate to all the 529 accounts for which an individual is the designated beneficiary, meaning the maximum amount a designated beneficiary can receive as a federal income tax-free withdrawal to pay expenses for elementary or secondary school tuition is $10,000, regardless of whether the funds are distributed from one or multiple 529 accounts. Although withdrawals in connection with K-12 qualified expenses will not be subject to federal income tax or the 10% federal penalty tax under current law, clients should be aware that there may be adverse state tax consequences, as some states did not adopt the federal tax change permitting withdrawals for K-12 qualified expenses.
Morgan Stanley Smith Barney LLC does not accept appointments nor will act as a trustee but will provide access trust services through an appropriate third-party corporate trustee.
The Morgan Stanley Global Impact Funding Trust, Inc. (“MS GIFT, Inc.”) is an organization described in Section 501(c) (3) of the Internal Revenue Code of 1986, as amended. MS Global Impact Funding Trust (“MS GIFT”) is a donor-advised fund. Morgan Stanley Smith Barney LLC provides investment management and administrative services to MS GIFT.
Additional disclosure if warranted:
While we believe that MS GIFT provides a valuable philanthropic opportunity, contributions to MS GIFT are not appropriate for everyone. Other forms of charitable giving may be more appropriate depending on a donor’s specific situation. Of critical importance to any person considering making a donation to MS GIFT is the fact that any such donation is an irrevocable contribution. Although donors will have certain rights to make recommendations to MS GIFT as described in the Donor Circular & Disclosure Statement, contributions become the legal property of MS GIFT when donated.
The Donor Circular & Disclosure Statement describes the risks, fees and expenses associated with establishing and maintaining an MS GIFT account. Read it carefully before contributing.
© 2019 Morgan Stanley Smith Barney LLC. Member SIPC. All rights reserved.
CRC 2408839 (2/19)