Five Strategies for Tax-Efficient Investing


One area of investing that is easy to overlook is the effect of taxes on a portfolio. Yet most investors can improve a portfolio’s bottom line by employing a few simple tax-efficient investment strategies.

Courtesy of: Bill Martin, CFP ®, Financial Advisor , 1845 Group at Morgan Stanley

With higher top tax rates now in effect, it may be time to ask yourself: Are you doing everything possible to improve your portfolio’s bottom line through tax-efficient investing? Here are five tried-and-true strategies to help lower your tax bill while improving your net return.

Take Advantage of Tax-Sheltered Accounts

To encourage Americans to save for retirement, Uncle Sam offers tax incentives in the form of IRAs, 401(k)s, 403(b)s and other qualified retirement savings plans. These accounts provide the opportunity to defer paying tax on contributions and earnings or to avoid paying taxes altogether on earnings, depending on the type of vehicle you choose.

By contributing as much as possible to these accounts, you can realize significant savings over time. For instance, contributing $400 per month to a traditional IRA (assuming deductibility rules apply) will save you nearly $22,000 in taxes over 20 years, assuming a 5% annual return and 25% tax rate.1 (Taxes, however, will be due on distributions at the time you make withdrawals.)

For 2014, you can contribute up to $5,500 to a traditional or Roth IRA. And if you’re over 50, you can contribute an extra $1,000. For employer-sponsored retirement savings vehicles such as 401(k) or 403(b) plans, you can contribute up to $17,500 in 2014 and an additional $5,500 if you’re over 50.

But keep in mind that most withdrawals prior to age 59½ from a qualified retirement plan or IRA may be subject to a 10% federal penalty in addition to any taxes owed on contributions and accumulated earnings.


Turn to Municipal Bonds for After-Tax Yield

In today’s low-rate environment, finding yield can be a challenge. Rates on high-quality corporate bonds have hovered at historical lows, and the yield on US Treasuries has not topped 4% since 2008. While municipal bonds, or “munis,” are no exception, they carry one significant advantage: Interest paid by muni bonds is generally exempt from federal and, in some cases, state and local taxes.

Consider this: A municipal bond yielding 4% translates to a tax-equivalent yield of 5.33%, assuming a 25% tax rate. In other words, you would need to earn 5.33% on a taxable bond to receive the same after-tax yield as a 4% municipal bond.

Remember, however, that any capital gains arising from the sale of municipal bonds are still taxable (at capital gains rates), and that income from some municipal bonds may be taxable under alternative minimum tax rules.

Avoid Short-Term Gain

Before you sell an investment, check to see when you purchased it. If it was less than one year ago, any profit will be considered a short-term gain. If it was more than one year ago, the profit will be considered a long-term gain. That’s important because long-term capital gains are taxed at significantly lower rates than short-term capital gains, especially if you’re in a high tax bracket.

  • Short-term capital gains are taxed at ordinary income rates which can be as high as 39.6%.
  • Long-term capital gains are taxed at a maximum rate of 20% in 2014.2

Considering those different rates, it can pay to look at the calendar before you sell a profitable investment. Selling just a day or two early could mean that you’ll incur significantly higher taxes.

Make the Most of Losses

 As most taxpayers know, the IRS lets you use long-term capital losses to offset long-term gains. In any given year, you can minimize your capital gains tax by timing your losses to correspond with gains. What’s more, you can carry forward unused losses to future years, and use them to offset future gains, subject to certain limitations.

You can also offset up to $3,000 of unused capital losses per year against ordinary income. So before taking a long-term capital loss, consider the timing of gains as well as ordinary income.

Get a Professional’s Perspective

Keeping an eye on taxes is a prudent way to try to enhance your investment returns over time. However, tax laws are complex, subject to change and may have implications you haven’t considered.



1Example assumes monthly pre-tax contributions of $400 over a 20-year period, a 5% annual rate of return, compounded monthly, and a marginal tax rate of 25%. Example is hypothetical. Your results will differ.

2Does not take into consideration Medicare tax on certain unearned net investment income or state or local taxes, which will vary.

If you’d like to learn more, please contact Bill Martin, CFP®. Morgan Stanley, McAllen TX 956-683-9158

Article by Wealth Management Systems, Inc. and provided courtesy of Morgan Stanley Financial Advisor.

The author(s) are not employees of Morgan Stanley Smith Barney LLC (“Morgan Stanley”). The opinions expressed by the authors are solely their own and do not necessarily reflect those of Morgan Stanley. The information and data in the article or publication has been obtained from sources outside of Morgan Stanley and Morgan Stanley makes no representations or guarantees as to the accuracy or completeness of information or data from sources outside of Morgan Stanley. Neither the information provided nor any opinion expressed constitutes a solicitation by Morgan Stanley with respect to the purchase or sale of any security, investment, strategy or product that may be mentioned.

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 the Internal Revenue Code or otherwise) with respect to the services or activities described herein except as otherwise agreed to in writing by Morgan Stanley. This material was not intended or written to be used for the purpose of avoiding tax penalties that may be imposed on the taxpayer. Individuals are encouraged to consult their tax and legal advisors regarding any potential tax and related consequences of any investments made under such account.

Morgan Stanley Financial Advisor(s) engaged RGVision to feature this article.

Bill Martin, CFP® may only transact business in states where he is registered or excluded or exempted from registration Transacting business, follow-up and individualized responses involving either effecting or attempting to effect transactions in securities, or the rendering of personalized investment advice for compensation, will not be made to persons in states where Bill Martin, CFP® is not registered or excluded or exempt from registration.

© 2014 Morgan Stanley Smith Barney LLC. Member SIPC.

CRC 942158 6/14

The Morgan Stanley Legal and Compliance Department has approved this article for use exactly as it appears. It may not be changed in any way. However, longer articles may be run in two or more parts as long as any disclaimers also appear in the respective parts. Please note that the non-solicitation clause must appear at the end of every article.