If there’s one thing that can really put a damper on the golden years of retirement, it’s taxes. Living on 80% of your pre-retirement income as per expert guidelines can be tricky when so much of it is being eaten by taxes.

Needless to say, it’s important to protect your hard-earned savings if you want to enjoy retirement. Going from earning a regular income to relying on investment returns can be a bit jarring, and you’ll need to leverage new strategies to preserve your nest egg.

Let’s explore savvy investment strategies that retirees can employ to manage their tax liabilities and secure their financial futures.

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Understanding the Basics of Tax Efficiency

So first thing’s first: what is tax efficiency? When we talk about tax efficiency, we’re referring to the practice of structuring investments to minimizes tax liabilities. 

It involves selecting investments that offer favorable tax treatment or locating assets in certain types of accounts to take advantage of lower tax rates or deferral opportunities.

But first, it’s important to understand how different investments are taxed and how those taxes impact overall returns.

Investment Taxation 101

  • Income Tax: Regular income from investments, such as interest payments or non-qualified dividends, is taxed at ordinary income tax rates.
  • Capital Gains Tax: The sale of an investment held for more than a year results in a long-term capital gain, which is taxed at reduced rates compared to ordinary income. 
  • Tax-Deferred Growth: Certain accounts, like 401(k)s and IRAs, allow investments to grow tax-deferred until withdrawals begin, at which point withdrawals are taxed as ordinary income.

Strategic, Tax-Efficient Asset Location

Asset location, or placing investments in the most tax-advantaged accounts, is a highly effective strategy for retirees. Holding interest-bearing investments in tax-deferred accounts can offset immediate income taxation, allowing for greater growth potential.

To manage your assets accordingly:

  • Position high-growth stocks in taxable accounts to benefit from lower long-term capital gains rates upon sale.
  • Allocate investments generating ordinary income, such as bonds and high-dividend stocks, to tax-deferred accounts like IRAs.

Vanguard notes two primary approaches to strategic asset allocation. Fixed-target allocation (steady) is a consistent, maintained strategy that requires regular portfolio rebalancing. 

The second, time-varying allocation is where the mix of assets changes over time to optimize returns based on the objective at hand. 

Roth Conversions for Tax-Free Growth 

Another potent strategy for maintaining tax efficiency during retirement involves the use of Roth IRA conversions. A Roth IRA offers tax-free growth and withdrawals, making it a compelling option for retirees who expect to be in a higher tax bracket in the future or for those seeking to leave tax-free assets to heirs.

The benefits of Roth Conversions include:

  • Tax-free withdrawals during retirement.
  • No required minimum distributions (RMDs) during the account owner’s lifetime, unlike traditional IRAs.
  • Potential to reduce estate taxes for heirs.

Tax-Loss Harvesting for Portfolio Efficiency

Tax-loss harvesting can be used to improve the tax efficiency of your investment portfolio. It involves selling investments that have experienced a loss and using those losses to offset taxable gains.

By implementing this strategy, retirees can reduce their overall tax burden. The Charles Schwab guide on tax-loss harvesting provides a comprehensive look at how this can be effectively managed. It touches on a few main points:

  • Identify investments that have declined in value and consider selling them to realize a loss.
  • Use the realized losses to offset any capital gains incurred during the year.
  • If losses exceed gains, up to $3,000 can be used to offset ordinary income on federal taxes, with additional losses carried to future years.

There are currently no limits on the number and size of conversions you can make from a traditional IRA. While you are limited to one rollover in a 12-month period from one traditional IRA to another, you can essentially perform unlimited rollovers from traditional IRAs to Roth IRAs.

Need Help Choosing the Right Tax-Efficient Investments?

At Alpha Wealth Funds, we understand that every situation is unique, which is why we offer a selection of investment funds that serve as smart, tax-efficient options for retirees. 

For example, funds such as the Alpha Low Volatility Fund and the Volatility Advantage Fund could be strategically placed within a retiree’s portfolio for tax optimization. 

The Insiders Fund may be suitable for a taxable account, focusing on long-term growth and capital gains. On the other hand, investments like the Alpha Diversified Fund could be considered for tax-deferred accounts, depending on their distribution characteristics.

Get in Touch With Us Today For Expert Investment Advice

The bottom line? Retirees have everything to gain from leveraging tax-efficient investment strategies. By understanding relevant tax implications and incorporating the right strategies, you can keep more of your investment returns.

As always, readers should consult with a financial advisor before getting started. For personalized investment management and planning, reach out to Alpha Wealth Funds, and our experts can help guide you through the process. 

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