Quizmaster, Doug Hutchinson, presents his quiz for the month. Here, Doug discusses strategies for tax efficient investing.
Consider this Scenario:
Your friend Stacy is considering purchasing the following investments:
- A high yield bond with a 8% coupon that is currently trading at $100
- A tax exempt municipal bond with a 2.5% coupon that is currently trading at $100
- An actively managed mutual fund with high turnover that typically generates short-term capital gains
Stacy has enough funds available in her traditional Individual Retirement Account (IRA) and her taxable individual account to purchase 1 or 2 of these investments in either account.
Stacy asks you “I’d like to purchase all three of these investments, but which account should I put each of these investments in? I’d like to be as tax efficient as possible.”
Solution:
Stacy should consider working with investment and tax professionals for guidance on her tax and investment situation, of course. That said, a general rule of thumb is to place the least tax efficient investments in a tax deferred account such as an IRA and to place the most tax efficient investments in a taxable account.
It would probably make sense for Stacy to hold the high yield bond in her IRA. The coupon payments from the bond will be taxed at the investors’ ordinary income rate, so sheltering this income from taxes by holding it in an IRA would likely be optimal.
For the municipal bond, it would probably make sense for Stacy to hold that bond in her taxable account. The coupon payments for this bond will be exempt from state and federal taxes. There isn’t really any advantage to holding an investment that generates tax exempt income in a tax deferred account such as an IRA.
It would probably make sense for Stacy to hold the actively managed mutual fund in her IRA. Short-term capital gains are taxed at ordinary income rates, so sheltering these short-term gains from taxes would provide an advantage over keeping this investment in a taxable account.
Where you hold various investments can have an impact on your tax liability and your after-tax investment returns. Holding different investments in different accounts based on the tax efficiency of each investment can be a critical component of tax efficient investing.
Check out another quiz from Doug's Quiz Corner!
To learn more about tax efficent investing or to discuss your strategy give us a call at 1-800-541-7774 or contact us here to get in touch with one of our Wealth Managers.
This quiz is intended for informational and illustrative purposes only. This material is not intended to be relied on as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The information presented is general information that does not take into account your individual circumstances, financial situation or needs, nor does it present a personalized recommendation to you. The information and opinions contained in this material are derived from sources deemed reliable, are not all-inclusive and are not guaranteed as to accuracy.
