Alright, this week’s article is the start of a mini-series. Mini-series may be a strong word as this will just be a two-parter, but I’m a child of the 80s and mini-series sound more exciting😉 Regardless, I am going to spend the next two posts talking a bit more about tax-smart investing.
Before we begin, I am going to repeat a couple of expressions/mantras/sayings you may have heard me share before. I often write about taxes, such as this article on Best Tax Savings Vehicles for High-Income Earners. Regardless, my mantras are specific to taxes. The first is – “It’s not what you make; it’s what you keep.” This simply means I want to know what your returns are after taxes. More importantly, it extends to making sure you are taking advantage of all of the IRS-approved tax savings strategies available to you. Why? Well, the other expression is I do not recommend clients tip Uncle Sam by paying more in taxes than necessary. I will never recommend anything illegal or even unethical. Simply, the IRS provides lots of strategies for saving taxes. It is then up to you as an individual to take advantage of them.
And before I forget, be sure to consult with your CPA and/or your CFP® if you are considering implementing any or all of these strategies. We don’t want to cause any tax headaches down the road that could have been prevented with a quick phone call beforehand.
BACKGROUND ON SEI AND MY RESOURCES
I’m going to begin with a bit of background. I utilize a third-party money manager to help me execute tax-smart investing strategies for my clients. There are a few reasons why. They include their years of experience doing this, their low cost, having a dedicated team of full-time, investment-only staff of over 100 professionals, and finally, because they handle billions of dollars.
The company itself is SEI. They are a publicly traded investment management company out of Oaks, PA, which is near Philadelphia. As I mentioned, they handle billions in assets and have been doing this for decades. Their tax-management strategies are the best I’ve come across over my years in the business. Plus, they can do it more effectively than I can and at a comparable price point.
With that background, these tax savings ideas I’m going to share in this article and the next one come directly from their tax team.
There are seven specific tax-smart strategies we’re going to cover today. Again, these strategies come from SEI. I firmly believe a few of these strategies you can do on your own, however, most of them require a dedicated team to execute properly.
Strategy 1 is tax-loss harvesting. The approach here is not all investment losses are a bad thing. You can use losses to offset any gains, which reduces your overall tax liability. Simply, you sell holdings that are now worth less than you paid for them. These losses, which are harvested, can then be used to offset gains for holdings you sell at a price higher than you paid. Again, the overall goal is to reduce your total tax bill. Losses can help offset gains and reduce your taxes.
Tax-Managed Portfolio Design
The next strategy is about proper design of portfolios so you are more tax efficient. The example here is to hold things that cause less taxes in taxable accounts. Holdings such as tax-free municipal bonds and/or other tax-favored investment strategies. Once again, the goal is to improve the after-tax returns.
Tax Lot Coordination
Strategy 3 is one where you need a full-time team to properly execute this more complex tax-smart strategy. It involves coordination between each tax lot of investments. Tax lots are a record of each transaction and its tax implications within your individual portfolio. Tax lot accounting is then a technique that tracks every tax lot in your portfolio and strategically identifies which lots to sell based on how long you’ve held them and gains and losses.
Tax-Smart Withdrawals and Rebalancing
Number 4 means you optimize trades to sell assets whenever they may need to be sold. This may be to rebalance the portfolio or even to generate income. Optimizing also looks at the number of transactions with the goal of reducing trades so you can avoid excess tax liability or even selling assets with lower gains.
Holding Period Management
Good ol’ number 5 brings us to how long you hold investments. Here we are talking about capital gains, which means you are selling an investment for more than you paid for it initially. As a refresher, long-term capital gains rates typically means a lower tax rate. You just need to hold the investment for over one full year. Additionally, by managing holding periods and looking at capital gains, you can spread gains out over time, which will help reduce the tax bill.
Portfolio Transition Management
The 6th strategy is another one that is more complex and in my experience you need a specialized team to execute it properly. Portfolio transition management happens when you are able to transfer assets from one investment portfolio to another. This may be preferred to selling them in one portfolio and then rebuying in another portfolio. In the latter situation, you may be incurring tax gains and also transaction fees. Transitioning them is a great way to avoid a tax-triggering event that creates a tax liability.
Efficient Gifting Strategies
Last but not least is strategy number 7. There are multiple ways you can use gifting strategies to reduce taxes in a single year or over multiple years. They can be everything from donating appreciated stock instead of selling the stock and donating cash to creating a Donor Advised Fund. If you are presently doing charitable giving or would like to do it down the road, there are great ways to achieve your goals in a tax-smart manner.
That was a quick review of seven specific techniques to be more of a tax-smart investor. Because you agree with me, you know it is not what you make. It is what you keep.
Again, thanks to SEI for these great ideas. In the next section we are going to talk more about tax-smart investing. Specifically, SEI has some great ideas on how to do some tax-smart planning this year.
FIRST REAL JOB - BENDING SPAGHETTI
Today’s flashback section is going to be about first jobs. I am specifically going to talk about my first real job. As some background, I started working when I was about 12. It started with a paper route and some lawn mowing. I enjoyed the paper route, but hated the lawn mowing. I learned quickly people are very particular about their lawns and everyone has a different opinion on how to properly mow a lawn. I also had a very brief couple of days working at my friend’s family car dealership. Another job I did not enjoy too much.
However, my first real job was at a place called The Spaghetti Bender. The Bender, as my friends called it, was located in Tallmadge, just off the circle. If you are familiar with Tallmadge you know of the big circle in town.
The Spaghetti Bender was basically quasi fast-Italian. You sat down and there was wait staff, but the food in the back was quick and easy to cook. The location was small and I think maybe had 20 tables in total. They were split between booths and individual tables.
I was able to get the job there as a friend of mine in high school was working there as a waitress. My job was to wash dishes, but I quickly started cooking too. Again, not a whole lot of complexity with the limited menu they had.
We did basic pastas, pizzas, calzones, and a few other items, such as fish, which was always popular during Lent. Fish was probably the most complex menu item as you had to put it in the pizza oven to cook, but it also included a side of pasta and microwaved broccoli. I told you it wasn’t fancy.
Pretty much everyone that worked there was in high school. There were a few college-age employees who were evening managers. They simply worked there a few more years than the rest of us.
Most of my friends either were working at pure fast food places or just washing dishes. So, I enjoyed being able to tell them I was a cook. Not that it was glamorous and we all smelled at the end of every shift regardless of where we worked.
A few quick memories of working at the Bender. First, if you worked a Friday or Saturday evening shift by the time you were done it was too late to go meet friends out. So, what we would do is cook some breadsticks and just hang out after the restaurant was closed, cleaned, and we had clocked out. Sometimes we would see what kind of crazy dishes we could make with any leftover ingredients that would have otherwise been thrown out. I used to make massive calzones.
Next, after working there a couple of years my car had the worst smell. The Spaghetti Bender was a 20-minute drive from my house. I guess all the times of driving home and stinking of fast-Italian eventually embedded the stink in the cloth seats of my 83 Chevy Cavalier. I cleaned my car often enough, but the smell did not go away until months after I stopped working there. I never knew how greasy I was after working there until the first time I took some cleaner and paper towels to the steering wheel. There were layers of grease and filth on the wheel. And this was after I thought I thoroughly washed my hands.
Regardless, it was a great first job for high school. I met some great people from other schools, didn’t have to spend all my time just washing dishes, and put enough money in my pocket I could buy things like skis and a nice rack stereo system. Unfortunately, the Bender closed years ago. Last time I drove by it the place had become a tattoo parlor.
As always, thanks for taking the time to read this. Please do not hesitate to reach out if I can be of help with your equity compensation-related questions. The easiest thing to do is to click the little green box that reads “Schedule a Meeting” that can be found at the bottom of every page on my website. Or, just click my Calendly link right here.
I’m Dan Johnson, CFP®, founder of Forward Thinking Wealth Management. I run a flat-fee financial planning and investment management firm located in beautiful Akron, OH. Although I am in Akron, OH, I work with clients regardless of location. I cater to owners of equity compensation positions who are looking to organize their financial lives, keep more of what they make, and do the things they want in retirement and even now.