Your Tax Return And Its Relationship To Your Investments


At Legacy Trust, we believe it is possible we will be in a low return environment for some time to come.  This presents an unsettling situation for all investors, but can be especially challenging for a taxable investor whose investment returns are subject to further reduction from taxes.  For the typical investor with both taxable and tax deferred investment accounts (IRA’s and other retirement assets) however, there is usually ample opportunity to structure a portfolio in a way that reduces Uncle Sam’s tax bite.  The options and importance increase substantially when an investor has set up family trusts, is in a high income tax bracket, or finds themselves subject to the 3.8% tax on investment income.  No matter an investor’s situation, a review of the tax return can provide important insight necessary to improve the after-tax return of many portfolios.

I recently reviewed the portfolio and tax return of an investor who had a significant IRA, a large taxable investment account, plus taxable income from a pension and Social Security.  To supplement their cash flow, the client had historically taken an annual distribution from their IRA that was about $70,000 higher than their required minimum distribution each year.  None of the three investment managers had a full understanding of the entire portfolio and they did not have the information necessary to understand the client’s tax situation.  This prevented them from considering tax efficiency and the excess IRA withdrawals appear to have cost the investor at least $15,000 in unnecessary income taxes last year.  This is obviously a big hit in any investment environment, but it is especially difficult to absorb when returns are low.

An advisor must also understand the tax characteristics of each investment utilized within a portfolio and place them within the right accounts, a concept I call “Asset Location”, to realize true tax efficiency.  There are certain rules of thumb when thinking about asset location, but unfortunately, no one strategy will be right for every investor.  An advisor must take the time to become familiar with each client’s circumstances to be successful developing an effective investment plan.  For those clients with a large estate, a review of the estate plan can be just as important as an income tax review given the top marginal estate tax rate of 40%.

Each investor’s circumstances are different and because the nature of a blog post prohibits covering this topic in enough detail to do it justice, I will simply suggest that every investor consider their after-tax investment return in the future.  No matter the investment return environment, doing so will allow you to keep more of what you earn on your investments.  Taking the time to understand your income tax, estate plan and personal circumstances is the only way an advisor can help you achieve true tax efficiency.  At Legacy Trust, this is common practice and we would be happy to help you review your situation to see if we can increase your after-tax return.