Tax efficiency

Sound Advice: A Personal Advisor video series

Vanguard Personal Advisor® sat down with our advisors and other experts to discuss your most pressing questions on topics such as taxes, health care costs, and retirement transition. This ongoing series will provide guidance to help you navigate challenges, make informed decisions, and meet your financial goals.

In these 4 videos, we'll review how we can help you weigh tax-efficient strategies, understand the withdrawal options for your unique situation, and make financial choices that consider how much you'll pay in taxes and when.

Gianni De La Cruz

CFP®, CTFA

The big picture

Get the big picture on building a tax-efficient portfolio.

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You work hard to invest and save money for your future. Of course, you want to keep as much of your earnings as you can. Paying taxes is never going to be the most fun or glamorous part of investing. But an advisor can make it less painful by helping you build a tax-efficient portfolio.

My journey to becoming a financial advisor was rooted in my own personal background. I grew up in poverty. My family didn't have the resources and generational knowledge to secure financial stability or seek financial education. It wasn't seen as socially acceptable to talk about your finances.

So for me, I wanted to be able to affect change for others and help them achieve more fulfilled lives. And I believe that starts with having conversations about finance.

Tax efficiency is a critical part of your long-term investment strategy. Many clients focus on trying to pay less and investment taxes year to year, but it's important to think even longer term than that. It's more about what you pay in taxes over your portfolio's lifetime.

In this video series, I'll walk you through three of the most important topics in tax efficiency and help you understand the key role a financial advisor can play and optimizing your portfolio.

When I work with clients on tax efficiency, I start by looking at the way your portfolio is constructed. I look at how your investments are spread across different account types because it matters for tax purposes. Your advisor can help you weigh strategies like asset location, tax-efficient investments, and tax-loss harvesting.

Next, we'll dig into financial planning. There's more to taxes than just your investment income. The financial choices you make-- like Roth versus traditional IRAs, Roth conversions, college, savings accounts, and health care savings accounts-- all play a role in how much you'll pay in taxes and when.

And finally, there's your withdrawal order as you start to tap into your different accounts in retirement. The order and timing matters for tax efficiency, and we can help you work through your options and come up with a plan for your unique situation.

It's no wonder they call it a tax code. It can be hard to decipher. Our advisors can help you crack that code and make a plan that stands the test of time. Tune into the next three videos where we'll discuss portfolio construction, financial planning, and withdrawal order as we take a deeper dive into tax efficiency. 

Portfolio construction

3 key strategies to manage tax efficiency.

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Taxes will always be a slice out of the pie at any earning level. It's a fact of life. Your advisor can help you keep them under control by building tax efficiency into your plan.

If I can go back in time, I would tell my own parents it's never too late to make a plan to accomplish your goals. They always felt like they were behind the proverbial eight ball and that they wouldn't have time to catch up. I think so many people feel that way, but in reality building out a portfolio that aligns with your future goals, not your past, is well within your control. It can put you in a better position to achieve financial stability.

Being prepared for what may come is half the battle. Having the discipline to follow through on good habits will allow you to weather life's inevitable storms. Your advisor is your partner in creating that plan and seeing it through. And tax efficiency is built into the fabric of every great plan.

Tax efficiency is one of our top priorities as advisors. And the way we help build your portfolio reflects that. I'm going to walk you through the key strategies we use. First, we're looking at your portfolio's construction. We'll help you take advantage of products like index mutual funds and exchange-traded funds where appropriate. They both come with built-in tax advantages because of their trading structures. ETFs are near the top of the heap when it comes to tax efficiency. And an advisor can help you decide if they're a good fit for you.

Then there's asset location. Sometimes, when clients come to me, I see they've gotten asset allocation correct, your percentage of stocks versus bonds. But their portfolio still may not be set up for tax efficiency because of where those assets live. I help clients make sure we put investments that aren't tax efficient into accounts where you can defer taxes and put investments that are tax efficient into your taxable accounts. I'm focused on helping them streamline their tax picture so they can keep more of their returns.

When it fits, we might discuss tax loss harvesting. That means looking for opportunities to realize losses to offset taxable gains, which can be a silver lining in rocky markets. Your advisor will know if you're in a good position to benefit from this approach.

The tax code can be complicated and a little tough to navigate. Advisors are there to decipher that code so you don't have to. We're here to help optimize your portfolio so that you can keep more of the money you've worked so hard to earn. 

Financial planning

Tax-smart ways to save for your goals.

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Financial planning can be a challenging topic. Some of us are taught at a young age that it's rude or taboo to talk about money or finances. And financial literacy isn't always easily accessible. It's a perfect storm for creating a topic that many people don't feel comfortable discussing. I believe we innately fear of the unknown.

I can attest, this was my personal experience growing up. My family didn't have the means to pursue financial planning experts. And it perpetuated a cycle of being unaware of how proper planning could enrich their lives. It's important to me, as an advisor, to earn my clients trust. The more I understand their lives, goals, and priorities-- the better I can serve them and help improve their financial well-being.

Strong financial planning starts with setting clear goals and finding the right paths to reach them. Many of my clients share common goals of retirement, education, and health care. The great news is, there are tax-smart ways to save for all of them. We can help you explore solutions. I like to start with your retirement savings accounts.

One way we control taxes is by helping you choose from a wide variety of retirement savings options. The biggest difference between account types is how they treat taxes. Roth IRAs are structured to get taxes out of the way up front. But with traditional IRAs and pre-tax 401(k)s, it works in reverse. With them, you'll pay taxes later, when you start drawing down the account.

Your advisor can help you interpret the details and decide which tax structure works best for you. Sometimes, there might be an opportunity to convert a traditional IRA into a Roth IRA for tax advantages. And we can help with that too. 529 plans are for education savings. And they usually offer great tax benefits.

Often, you can deduct your contributions on your state tax return up to your state's limit. You can put your child on a solid path to higher education while lowering taxes at the same time. 529s offer tax-deferred growth and tax-free withdrawals for qualified education expenses. You may have heard the letters HSA floating around in conversation about health care. They stand for "health savings account."

HSAs are a bit of a hidden gem. They're often overlooked, but they're definitely worth considering. Your savings in an HSA can pay for medical expenses today or in the future. Your contributions are pre taxed. And withdrawals for qualified medical expenses are tax free. HSAs provide a great benefit to high-deductible plans they can also help cover health expenses as you work toward meeting that deductible.

One of my favorite parts of being an advisor is helping people find these pathways to saving for their goals in a way that helps them maximize tax savings. This is what financial wellness looks like. And this is what energizes me to continue serving our clients. 

Withdrawal order

How order and timing can impact your strategy.

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Beginning to withdraw from your portfolio in retirement is an important moment in your life. It's what you've worked for all these years. This is the next big chapter.

Your advisor can help navigate uncharted waters while maintaining a tax efficient strategy that adheres to your spending goals. I think for a lot of people, it can be extremely stressful to navigate the nuances of taxes, and then try to figure out how to apply them to their particular portfolios.

I've seen some people make financial choices with the goal of minimizing their taxes in the present, but they weren't necessarily considering their long term strategy and big picture. My role as an advisor is to help my clients act with those long term goals in mind.

I can walk you through a tax efficient path for making withdrawals. It makes sense for most people to consider starting with any retirement accounts that have a required minimum distribution, or RMD for short. Then, in most cases, you'll move on to taxable accounts.

Where you go from there depends on where you think your tax rate will be in the future. You want to pay taxes when you think they'll be lowest, so if you expect your future tax rate to be higher, you want to think about withdrawing from your tax deferred accounts, followed by your tax free accounts.

But if you expect your future tax rate to be lower, you'll want to consider withdrawing from your tax free accounts before your tax deferred accounts.

Once you start drawing down from your non retirement accounts, think about spending portfolio dividends and interest first, instead of reinvesting them. This can potentially help you reduce your tax impact, and it's one way I make sure clients are able to keep more money in their pockets.

Timing is a factor as well. You could withdraw from your traditional or Roth IRA any time, but you could face penalties. 59 and 1/2 is a magical half birthday to remember, because it's generally when you get to start making penalty free withdrawals.

Much like the tax code, rules around traditional and Roth IRAs can be complex. Advisors are here to help it all make sense. There's a lot to think about when it comes to investment taxes. A financial advisor can help you simplify these intricate concepts. Creating a clear path forward for my clients is important to me. I love what I do because I can empower investors. 

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