Our Perspectives
Apr 14, 2023
Charnella Grossman
The Importance of Tax Mitigation as an Investment Strategy
At Market Street, we believe that a strategic approach to tax mitigation can significantly enhance the after-tax returns in your investment portfolio, ultimately resulting in increased wealth over time. Tax mitigation, when executed appropriately, allows clients to maximize returns on their investments while minimizing tax liabilities. Five of the most effective tax-efficient investment strategies are:
Asset location: By positioning investments across asset classes and account types (taxable, tax-deferred, and tax-exempt), investors can maximize returns and minimize taxes. A tax-efficient asset placement strategy can increase after-tax returns (or “tax alpha”) by up to 0.90% annually according to the graph below. Over a long time horizon, this seemingly small percentage can have a considerable impact on wealth accumulation.
Tax-loss harvesting: Realizing losses on underperforming investments to offset gains on other investments can reduce overall taxable income. A study by Vanguard found that a tax-loss harvesting strategy can potentially add more than 1% to an investor's annual after-tax returns.
Municipal bonds: These are debt securities issued by state and local governments that are generally exempt from federal taxes and, in some cases, state and local taxes as well. They can provide a tax-efficient income stream. There are certain types of municipal bonds, known as private activity bonds, that may be subject to the AMT. The AMT rules for private activity bonds are complex, and whether or not they will trigger the AMT depends on a variety of factors. Not all municipal bonds are subject to the AMT.
Charitable giving strategies: Charitable donations can provide tax benefits while supporting philanthropic causes. Private Foundations and donor-advised funds (DAFs) allow clients to contribute assets to a fund and receive an immediate tax deduction while retaining the ability to recommend grants from the fund over time. Charitable trusts can also provide immediate tax benefits by allowing donors to take a deduction for the present value of the gift when it is made. Additionally, the transfer of assets to the trust can remove them from the donor's taxable estate, reducing potential estate taxes.
Real estate investments: Real estate investments, such as rental properties or commercial properties, can offer tax advantages through depreciation, deductions for property expenses, and preferential tax treatment for long-term capital gains.
Tax mitigation is an essential component of any successful investment strategy. It is imperative to discuss any anticipated tax changes with your Market Street team to help maintain an up to date strategy designed to maximize tax efficiency.
Sources:
https://www.putnam.com/literature/pdf/II922.pdf
Disclaimer:
This presentation has been prepared by Market Street Trust Company. The views expressed herein represent opinions of Market Street and are presented for informational purposes only. They are not intended to be recommendations or investment advice and do not take into account the individual financial circumstances or objectives of the investor who receives them.
Certain statements included in this presentation constitute forward looking statements. Forward looking statements are not facts but reflect current thinking regarding future events or results. These forward looking statements are subject to risks that may result in actual results being materially different from current expectations.
Past performance (before and after taxes) does not guarantee future performance. There is no assurance that Market Street Trust Company investments will achieve their objectives, or that they will or are likely to achieve results comparable to results shown herein, or will make any profit, or will be able to avoid incurring losses. Exposure to foreign currencies may cause additional fluctuation in the value of any investment. Each investor must assess the suitability of an investment, the investor’s tolerance for risk and the impact on the investor’s diversification strategy. This presentation does not constitute an invitation to buy or an offer to sell securities, or any other products or services.
This is intended as general information only. Investors maybe required to meet certain criteria under the securities laws in order to qualify for certain investments. Any discussion of U.S. tax matters is not intended and cannot be used or relied upon for the purpose of avoiding U.S. tax-related penalties. Please visit our website for additional information concerning Market Street’s investments and investment updates. As always, please feel free to contact us if you would like to learn more about our investment program.
