How To Defer Investment Taxes

Tax deferral means postponing the payment of tax on income, interest, dividends, and capital gains until the investor takes possession of them. The simplest form of tax deferral is by putting money in your 401k or IRA. You put a portion of your income away before taxes so that you can use that income later in retirement. That’s the basic form of tax deferral. But did you know that there are advanced forms of tax deferral?

How it works

Advance Tax Deferral involves placing highly taxable investments in your tax deferral accounts and placing your less taxable investments in your taxable accounts. Confused? This one is best explained with an example. For simplicity, we’ll use round figures.

Suppose your a millionaire. You have a one million dollar portfolio exactly and your asset allocation is 50% equity and 50% bonds. The bond fund pays 4%.

Your portfolio is divided into two accounts: an IRA, and a taxable joint account with your wife. Each account has $500,000 in it.

Most people would put 50% bonds and 50% equity in both IRA and joint account. This would mean that $250,000 is invested in bonds in a taxable account. At 4% interest, the bonds would generate $10,000 of interest that is added to your tax return at the end of the year. Someone in the 25% tax bracket would owe $2,500 extra in taxes that year. More importantly, after taxes you’d only make $7,500 on your bond fund, which is equivalent to a real after tax return of 3%, NOT 4%.

Using an advanced tax deferral strategy you’d allocate all of your fixed portion of your investments in your IRA account. This would equal $500,000 which would pay dividends of $20,000 ($500,000 x 4%), none of which would be added to your taxes this year. Your real after tax return is the FULL 4%.

You can further lower your tax bill by Tax Loss Harvesting, and investing in low turnover index funds in your taxable account.

About the author

Richard T. Feight, CFP®

Among independent financial advisors, Mr. Feight is one of the most well known and highly respected “Fee-Only” financial planners. Since 1997, Rich has dedicated his career to offering low cost “Fee-Only” comprehensive financial planning and investment advice. Rich assists his clients in organizing their finances so that they can retire on time.Rich is a graduate of Michigan State University where he received his degree in Finance. Rich has earned the Certificate of Financial Planning from The College for Financial Planning in Denver , Colorado that was comprised of intense graduate level classes grounding him in the various foundations of financial planning. He is a CFP® (Certified Financial Planner®) since 2001, meeting the experience, education requirements and passing the two-day, 10 hour exam, making him one of the few in the country who hold the designation. Since 2003, Rich has subscribed to the stringent and mandatory annual educational hours, experience, and code of ethics to meet the requirements to be a NAPFA Registered Financial Advisor. Out of the 800,000 individuals in the country who claim they are financial advisors/planners, fewer than 1,300 in the country qualify for the membership; Rich is one of them.

Rich is the President of the Financial Planning Association (FPA) of Michigan . The FPA of Michigan is one of largest and influential chapter in the country. Rich was recently named President for Transportation Toastmasters Club 4776 downtown Lansing . He has been quoted in both local and national media from Noise Magazine to CNBC, and Bloomberg, and industry news publications such as Investment News and Financial Advisor Magazine. Rich enjoys public speaking and has spoke at industry educational meeting, high schools, and executive investment clubs, AARP conferences, and business educational seminars for companies looking to educate their employees. Rich views his role as a Fiduciary for his clients as the single biggest key to any planning relationship and strives to provide the most competent, unbiased and objective advice in the financial planning profession today.

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