Tax-Efficient Investing

It's not what you earn—it's what you keep. Taxes can significantly impact your investment returns over time. Understanding tax-efficient investing strategies can help you keep more of your money working for you.

Understanding Investment Taxes

Types of Investment Income

• Ordinary Income - Taxed at your regular income tax rate (up to 37%)
• Qualified Dividends - Taxed at preferential rates (0%, 15%, or 20%)
• Long-term Capital Gains - Assets held 1+ years, taxed at 0%, 15%, or 20%
• Short-term Capital Gains - Assets held less than 1 year, taxed as ordinary income

The Impact of Taxes on Returns

Consider two investors each earning 8% annually. One pays 30% in taxes annually, the other defers taxes until withdrawal. Over 30 years, the tax-deferred investor ends up with significantly more—potentially 50%+ more depending on circumstances.

Core Tax-Efficient Strategies

1. Asset Location

Place investments in the right type of account based on their tax characteristics:

• Tax-deferred accounts (401k, Traditional IRA) - Bonds, REITs, actively traded funds (high turnover)
• Tax-free accounts (Roth IRA, Roth 401k) - Highest growth potential investments
• Taxable accounts - Index funds, tax-managed funds, municipal bonds, individual stocks held long-term

2. Tax-Loss Harvesting

Sell investments at a loss to offset gains and up to $3,000 of ordinary income annually. Excess losses carry forward indefinitely. Key rules:

• Avoid the wash-sale rule: don't buy substantially identical securities within 30 days
• Can reinvest in similar (but not identical) investments to maintain exposure
• More valuable in higher tax brackets

3. Hold Investments Long-Term

Holding investments for at least one year qualifies gains for lower long-term capital gains rates. This alone can reduce your tax rate from up to 37% to 0-20%.

4. Use Tax-Efficient Funds

Index funds and ETFs are inherently more tax-efficient than actively managed funds because:

• Lower turnover means fewer taxable events
• ETF structure allows for tax-efficient redemptions
• No surprise capital gains distributions

5. Maximize Tax-Advantaged Accounts

Contribute the maximum allowed to tax-advantaged accounts:

• 401(k): $23,500 (2025), plus $7,500 catch-up if 50+
• IRA: $7,000 (2025), plus $1,000 catch-up if 50+
• HSA: $4,300 individual / $8,550 family (2025)

Advanced Strategies

Roth Conversions

Converting traditional IRA funds to Roth IRA can make sense when:

• You expect to be in a higher tax bracket in retirement
• You have a low-income year
• You want to reduce future RMDs
• You want to leave tax-free assets to heirs

Be strategic—convert in years when your income is lower to pay taxes at lower rates.

Charitable Giving with Appreciated Securities

Donating appreciated stock directly to charity allows you to:

• Avoid capital gains tax on the appreciation
• Deduct the full fair market value (if held 1+ years)
• Give more to charity at the same after-tax cost

Qualified Opportunity Zones

Invest capital gains in designated opportunity zones to potentially:

• Defer original gain until 2026 or sale
• Eliminate taxes on new gains if held 10+ years

Common Tax Mistakes to Avoid

• Ignoring asset location - Placing bonds in taxable accounts
• Selling winners in December - Consider waiting for long-term treatment
• Forgetting the wash-sale rule - Buying back too soon
• Not rebalancing tax-efficiently - Use new contributions and dividends
• Missing tax-loss harvesting opportunities - Down markets are opportunities
• Overlooking state taxes - Colorado has a 4.4% flat income tax

Colorado Tax Considerations

For Douglas County residents:

• Colorado has a flat 4.4% state income tax (reduced in 2024 from 4.55%)
• No special treatment for capital gains—taxed as regular income
• Social Security is tax-free for those 65+ (and phased in for younger retirees)
• Municipal bond interest from Colorado issuers is state tax-free

Working with Tax Professionals

Tax-efficient investing requires coordination between your investment advisor and tax professional. Look for advisors who:

• Actively manage for tax efficiency, not just returns
• Communicate with your CPA or tax preparer
• Consider taxes in every investment decision
• Provide tax reports that make filing easier