Understanding Tax-Efficient Investing: What Money Goes Where

Summary

In this informative video, Marc Lichtenfeld, Chief Income Strategist with the Oxford Club, explains how to maximize tax efficiency in investments. He emphasizes the importance of understanding how interest, dividends, and capital gains are taxed differently and how to structure investments accordingly. Lichtenfeld advises placing high-tax-burden investments like bonds in tax-deferred accounts and lower-taxed assets like dividends in taxable accounts. He also touches on strategies for managing foreign stock taxes and the implications of required minimum distributions (RMDs). With practical advice, he helps viewers save money on taxes and retain more of their earnings.

Takeaways

• 😀 Tax efficiency is crucial for saving money, and it’s not just about how much you make, but how much you keep.
• 😀 Interest income from bonds, CDs, and similar investments is taxed at a higher rate (22% or above), compared to dividends or long-term capital gains, which are taxed at a lower rate.
• 😀 Long-term capital gains and dividends are taxed at 15% for income under $523,050 (married) or $492,300 (single). For higher incomes, the tax rate increases to 20%.
• 😀 A 3.8% surtax applies to high earners ($250,000 for married, $125,000 for single).
• 😀 The IRS's tax system can be complex, especially regarding tax rates for dividends and capital gains vs. interest income.
• 😀 Tax-deferred accounts are ideal for investments that generate interest, as they will be taxed at a higher rate in taxable accounts.
• 😀 If you have investments paying interest and dividends, you would be better off holding interest-paying investments in tax-deferred accounts to minimize tax burden.
• 😀 If you're close to the age when required minimum distributions (RMDs) kick in, avoid having investments tied up in bonds that you may need to sell to meet RMDs.
• 😀 Partnerships like MLPs (Master Limited Partnerships) should be held in taxable accounts since their dividends are already tax-deferred.
• 😀 Holding international stocks in taxable accounts is recommended, as foreign governments may take taxes out before you receive the dividend, but the U.S. offers a foreign tax credit for taxable accounts.
• 😀 Foreign taxes on dividends from stocks held in tax-deferred accounts are not eligible for the U.S. foreign tax credit, meaning that money is lost permanently.
• 😀 Use tax-efficient investment strategies to maximize your wealth while keeping more of your money for personal enjoyment, like hot dogs and fireworks on the 4th of July.

Q & A

What is the main focus of the video script?

The main focus of the video is on tax efficiency and how to structure investments to minimize taxes, particularly in relation to interest, dividends, and capital gains.

Why is it important to focus on 'what you keep' rather than 'what you make' in terms of income?

Focusing on 'what you keep' emphasizes the importance of managing taxes and expenses in a way that allows you to retain more of your earnings, rather than just making a lot of money without considering how much is lost to taxes.

How are interest, dividends, and capital gains taxed differently?

Interest is taxed at ordinary income tax rates, which can be higher than the tax rates on dividends or long-term capital gains. Dividends and capital gains are taxed at a lower rate, with capital gains taxed at 15% for most individuals and dividends also taxed at 15%, though higher rates may apply for those with higher incomes.

What is the significance of tax-deferred accounts for managing investments?

Tax-deferred accounts are important for holding investments that generate interest because interest is taxed at a higher rate than dividends or capital gains. By holding interest-generating investments in tax-deferred accounts, investors can reduce their immediate tax burden.

How should interest-generating investments be managed in taxable accounts?

In taxable accounts, it's more advantageous to hold investments that generate dividends or long-term capital gains because these are taxed at a lower rate. Investments that generate interest should be placed in tax-deferred accounts to minimize tax liabilities.

What is the strategy for managing tax-deferred accounts when nearing retirement age?

When nearing retirement age, it's important to ensure that investments in tax-deferred accounts are liquid enough to meet required minimum distributions (RMDs). For instance, it’s advisable not to buy long-term bonds in a tax-deferred account if you'll need the money within a year.

Why should partnerships like MLPs (Master Limited Partnerships) be held in taxable accounts?

Partnerships like MLPs should be held in taxable accounts because their dividends are already tax-deferred, meaning you won’t pay taxes on most or all of the dividends until you sell the investment. Holding them in a tax-deferred account could lead to additional complications, such as unexpected tax penalties.

Why are international stocks generally recommended to be held in taxable accounts?

International stocks, except for those from Canada and the UK, often have foreign taxes withheld on their dividends. If these stocks are held in a tax-deferred account, you won't receive a foreign tax credit, which means you would lose that money to taxes without any relief from the IRS.

What is the 3.8% surtax, and who is affected by it?

The 3.8% surtax is an additional tax on investment income that applies to individuals making over $250,000 if married or $125,000 if single. This surtax applies to income from dividends, capital gains, and other investment income.

What should you do if you have to make a withdrawal from a tax-deferred account soon?

If you need to make a withdrawal from a tax-deferred account soon, it's best to keep that money in liquid assets like cash instead of investments like bonds. This ensures that you won't have to sell investments at an inopportune time to meet your withdrawal requirements.