Want to save on taxes? Matt and I discuss 8 different strategies that can help you keep more money in your pocket. We cover the first 3 tips in this first podcast, followed by 5 more in the next podcast.
- Use Index funds over actively managed funds. This is generally great advice, but also better at saving on taxes due to less turnover of holdings.
- Use ETFs instead of mutual funds. ETFs are a unique “wrapper” that avoids you from paying taxes on interest and dividends.
- Hold the right asset in the right account. Tax-deferred and Tax-free accounts (401k, IRA, etc) are great for bond funds because you avoid paying taxes on the interest and dividends each year.
- Tax-loss Harvesting. Make lemonade out of lemons by intentionally taking a loss and deducting it from your taxes or offset other gains and pay no tax.
- Tax-Lot Management. It’s important to sell the correct shares so that you take advantage of short-term or long-term gains/losses in your account.
- Savvy Rebalance. Use additional funds or tax-deferred/free accounts to do your rebalancing and avoid paying capital gains.
- Long-term Investing Horizons. Long-term capital gains are taxed at a lower rate than short-term. Invest for the long run!
- Charitable Giving. Donating appreciated assets helps you avoid paying taxes on capital gains.
[00:00:00] Mike: Welcome to financial planning for entrepreneurs and tech professionals. I'm your host, Mike Morton certified financial planner and charter financial. And on today's episode, I share eight tips and strategies to maximize your tax savings or to pay less in taxes. Now, in this first episode, Matt and I cover the first three tips.
And in the second episode, right after this and the podcast feed or the following five, enjoy the show.
[00:00:30] Matt: Welcome to real financial planning broadcast on WK Excel. 101.9 in Manchester, 103.9 FM in Concord and 1450 AM. Everywhere. I met Robeson and I'm joined as always by Mike Morton the host of the outstanding podcast. I think it's outstanding because it frequently features me financial planning for entrepreneurs and the owner of Morton financial advice.
Mike, how are you doing?
[00:01:00] Mike: Doing great, Matt. I'm impressed. You've got all the channel dials. They're dialed in all the numbers. That's awesome.
[00:01:05] Matt: It's exciting stuff. So for long-time radio listeners, you may know this, but WK XL dominates The center of the state. And it's 103.9 FM and 14:50 AM. So it's got a a pretty good listening area. But it just doubled it. And now covers the biggest city in the state of New Hampshire Manchester, the gate city.
I don't know what that even means. , as a New Hampshire person I should really know this. I don't know what that means. A gate from where to, where is it? Like the golden gate? It's not, I can tell you. It's not like the.
I don't know. I don't know what it is. Anyway. The point is we're All over Manchester now, which is really super duper exciting. So my Morton, .
About a month ago, we did a show end of year tax strategies and it felt premature. We thought maybe people are not paying attention to this, but the whole point of that discussion was they really should be because there were a bunch of things you could do in order to.
Get ahead of the game. And then you really had to do at that point, but now we really are coming into the home stretch of the year, and it really is time to pull the trigger on all the tips and tricks that you can do to save on your taxes. So you have prepared sort of a holiday stocking stuffer of. Tax goodies. And that doesn't sound like much. That's
[00:02:23] Mike: It's terrible.
[00:02:24] Matt: goodies is. And I think it makes me think of like an IRS auditor with a Santa's beard. But the point is you've got a sack full of ideas. We have some unknown number of ideas that we're going to cover. We're probably going to do this as a two-parter.
So here we go. Here we go. Mike Morton tax ideas. You start wherever you want to start wherever you want. This is your domain.
[00:02:45] Mike: Yeah, we thought we'd go over some of these and they're not necessarily year-end strategies. So some of them are, or could be but a bunch of these kind of apply throughout the year. So these are ways that you can maximize after tax returns. So there are financial strategies to implement, to save money on tax.
[00:03:06] Matt: No, just to be clear, there are two words. When it comes to Texas there's avoidance And evasion, one of them is legal. You weren't talking about the legal one.
[00:03:18] Mike: We are going to do the legal one here, there. Yeah. You might've read some things in the newspaper about tax strategies. In fact, Matt, it's funny. I was just reading literally this morning about Amex and their a tax strategy proposals to small businesses and how they weren't quite the legal variety.
[00:03:36] Matt: Oh, no. Oh no. Okay. Everything we
say here, listen for those. We're doing this, it's being broadcast, so it's not like the FBI is listening into us. We're not having our phones tapped here or anything, but a big disclaimer, this is all legal stuff. This is all good stuff you can do. Save on tax.
[00:03:51] Mike: Yeah, exactly. Exactly. So let's just dive in. The first one is within your portfolio to favor index funds over actively managed fund. Okay. So we've talked about index funds in the past. You and I are both fans of low cost index funds. So just own the entire us stock market in a super low cost fund, or you own the developed markets in a low cost index fund.
And this is literally just tracking as you know, That in DC and it doesn't cost a lot. So there's not a lot of managers having to buy and sell things. You can use computers to do some of that have a few managers, but you're not actively doing research and figuring out what the buy and sell. You're just tracking the index.
So it keeps the costs down and the returns are fantastic. When you look out 10 years, the, I think it's, we're 70, 80% of actively managed funds under perform. The index. So the index is outperforming 80% of actively managed funds over a 10 year time horizon. So the results are really good as well.
So favor indexing, overactive manager. Why for taxes? Is that better? You have less trading. Okay. So it keeps the cost down. It keeps the trading down. It keeps taxes on those traits. Every time you have a. So when you're trading, you know this in your own account, you have a trade, you have capital gains.
You're going to pay taxes on that. Same is true with actively managed funds. So favoring the indexing over the active keeps your taxes lower.
[00:05:23] Matt: Now if you are in an active manner. Fund and you are accruing games, hopefully gains. And I mean in this market probably gains who knows next year we might be overpriced. So it might be a lot of losses. There are strategies that you've covered on this show for tax gain, harvesting tax loss, harvesting. So if you're not able to be, to make use of this trick, because you're in a lot of your assets are in actively managed funds, you should still pay attention to those gains and losses, right?
Because there's still stuff you can do.
[00:05:53] Mike: Oh, absolutely. And let me say this too, Matt. Yeah, you're going to have gains and losses in your own accounts. And so you want to. And we'll talk about that a little bit later, too. You want to be tax aware when you're making trades. Okay. But these active, you don't have any control over that.
So the managers making trades and having taxable distributions, and it might be a terrible year for you to have that taxable distribution you're high in high income that year about to retire or something. So again, the actively managed, you're not really in control, whereas in your own account, you can decide when to take those gains or losses.
[00:06:26] Matt: Yeah, that's it. That was one of the episodes. For one thing, I am learning as I do these shows with you, and that was one of the episodes that was an eye-opener for me, that. Harvest tax losses. You can also harvest tax gains depending on your, the kind of year you're having. What kind of a tax bracket you're falling into.
So if that is perking up your ears, if you find yourself in this situation, check out the back episodes of financial planning for entrepreneurs with Mike Morton, all those episodes are in there. And that I found that one pretty insane.
[00:06:58] Mike: Yeah, and I think we're going to get the tax loss. Harvesting is
[00:07:01] Matt: oh, this is in your sack of goodies.
[00:07:04] Mike: That's right. It's in there. It's in there somewhere.
[00:07:06] Matt: Is there anything chocolate in there?
That's not necessarily Tax-related because that's sounds better to me. You know what? This is, what we're doing is we're. We're being needlessly Christian about this. We should be a little bit more Jewish about this. This should be the Hanukkah show is what it should be. We've got eight, eight nights, eight Crazy.
nights of tax stuff.
[00:07:25] Mike: Crazy.
[00:07:26] Matt: But before we go full Sandler on this Adam Sandler, by the way, from New Hampshire, let's what's next?
[00:07:31] Mike: I did not know that. Look, you're full of useful information as well.
[00:07:37] Matt: I let's define that another show, what I'm full of. Okay. Sorry. All right.
Number one is just in general being index funds, by the way.
Good general advice, right?
[00:07:45] Mike: Yeah, exactly. For multiple reasons, but it also falls under this tax idea. All right. Number two, using ETFs exchange, traded funds rather than mutual funds. Okay.
[00:07:58] Matt: going to have to refresh me on exchange traded funds
because you've referred to them on the show before. It sounds interesting. Tell
[00:08:04] Mike: Yeah, let me give you the refresher there's ETFs. So there's a mutual funds. So how, 50 years ago, I want to get into a low cost index fund or an actively traded fund.
I'm investing $10,000 in someone else managing that monitor either passively or actively. I put it into a mutual fund and the mutual fund has a fund manager and they're doing the trick. Whether they're following an index or they're doing actively, so that's a mutual fund. They settle at the end of the day.
And just a little logistics you run into you put in tent, you do it by dollars. I want to put in $10,000 into this mutual fund and it closes after the trading day. So between four and 5:00 PM. Is when you actually, now you own that fund and you buy it at the exact spot price of whatever's owned underneath.
So if they own 10 stocks and it's a hundred dollars and you invest 10,000, you will get to buy it at exactly $100. Okay. There's no spread. And like you and I negotiating, Hey, yeah, give me, I'll sell it for this or buy it for that. Okay. That's a mutual fund and ETF is relatively newer, about 20 years.
Give or take it's a different kind of rapper, but the exact same idea. I still want to invest in that. So I still want to put in my $10,000, it's a different wrapper for the same type of product. It buys you buy it during the trading day. Okay. So during, when the market is open is when you will buy and sell.
And it's literally just a different wrapper around the same thing. So you want to buy the S and P 500, you can buy a mutual fund version. You could buy an ETF. Okay. So then the question is what are pros and cons are different? What is what's the different wrapper mean? I told you one is that the mutual fund settles at the end of the day for exactly the price of the underlying assets ETFs have a little bit of a.
Between, that we're buying and selling something like I'm transferring to you, you say I'll sell to for this amount. It doesn't really matter. What's inside of it. We can just agree to whatever price you want to buy and sell the whole thing. Now, of course it does trade at the underlying value from if there's a hundred stocks in there and they're worth $10,000, you're going to sell it to me, for $10,000.
Cause that's what it's worth. But it's good to know that there's a little bit of a spread what's called a bid ask spread and they trade during the day. So you can get in and out of these things, just like you can. Mutual funds , you can only trade them once a day, whereas ETFs, you can buy and sell them like a stock, all day long.
I do not recommend doing that, but it is possible. So there's a couple of answers to what mutual funds versus ETFs are. I have not told you the taxes yet. Why it's good, but I'll pause there in case you got any questions on that.
[00:10:34] Matt: That makes sense. So just read this back, the whole idea of going. 50 years ago is that.
it's a, I'm going to stay with a holiday theme here. It a Festivus for the rest of us is that mutual funds gave individual investors a way to very easily get into the market participate. and
you don't have to be a . Stockbroker. You don't have to be a high wealth individual, and that was a real change. And so what you're saying is that the. Is just building on that basic idea, slightly different approach. And it has this feature of there is a spread, but you have more flexibility of trading during the.
[00:11:12] Mike: So here's the other reason why the ETFs are more tax efficient than mutual fund. When you are buying and selling, people are buying and selling. , those mutual funds are these ETFs. And so the manager of the fund manager needs to give back cash to the people that sell it or taking cash and buy the underlying stocks for the people that buy the ETF.
And so you have to match up these buying and selling opportunities. And just as in your own taxable brokerage account, if you sell something with a gain, you have a capital gains. So if the manager has to sell some of the assets to hand cash back to somebody, then you have a capital gains and everybody has to pay part of that capital gains. That's in the mutual fund.
In the ETF wrapper. You're able to do these exchanges underneath and have less taxable events. And so therefore you save on taxes.
[00:12:06] Matt: I got to say, this is one of the more complicated ideas. Encountered here on the show, because it feels weird to me that you could have, this is like the old, you could have your cake and eat it too, which I never understood. it's if you have it, you've eaten it. like how does want to have something and not eat it.
But the point is you possess it, you own it, but you haven't ingested it you, you haven't taken the distribution.
[00:12:33] Mike: So it is more tax efficient. Now we're not talking tens of thousands of dollars here. We're talking hundreds of dollars throughout a year, but it still is more tax efficient. So that's why I always default to owning ETFs in taxable accounts because of the tax efficiency.
[00:12:49] Matt: And it does this. How does this relate to the overall directional advice of your first point in general index funds tend to outperform actively managed funds, I assume. Are there. mutual funds that are actively managed, not actively managed is the same thing. True with ETFs.
[00:13:13] Mike: Yeah, absolutely. So you can think of mutual funds and ETFs there's exact same universe on both sides. So which do you buy? It doesn't really matter that the fees are the same, what they own is the same. So look, here's the. Just use ETFs,
[00:13:29] Matt: Just use ETFs,
[00:13:30] Mike: low cost index funds, ETFs.
[00:13:34] Matt: Roger. All right. That's that is actually that's as straightforward as my brain can take our look. Let's bang out one more of these. We're going to have to take a break in a few minutes, but let's let's do one more. What's number three on your hit list here.
[00:13:47] Mike: So we just were talking about holding ETFs. In taxable accounts, that's just your regular kind of brokerage account. Versus when I say taxable account mat, it's your checking savings, brokerage account things where you are paying taxes on that money. So if you get interest dividends, capital gains buying and selling, you have to pay taxes.
There's two other types of accounts tax deferred. Okay. That's your 401ks traditional IRAs or there's tax free. And that would be your Roth. Where your Roth 401k. If you see the word Roth or your HSA is also a tax free account. Okay. So three different account types.
[00:14:27] Matt: Now remind us we've also done a number of shows on this but just remind us for a second, the critical difference. IRA Roth.
[00:14:38] Mike: Yeah, traditional IRA and Roth IRA. The traditional, the work with a capital T traditional IRA means it is tax deferred. I have not yet paid taxes on that money. I put in $6,000, but I have not paid tax. On it yet, eventually the government's going to want taxes. So that's why it's called tax deferred. You pay taxes when you take the money out.
So you're deferring taxes. Roth. IRA is you've already paid taxes on the money. You're putting your 6,000, but you've paid taxes on that. It grows tax free and you're never going to pay taxes again because you've already paid taxes. So the point is we're going to pay taxes once. Do you want to pay them now or do you want to pay them in the future?
Okay. And that's the difference between traditional.
[00:15:23] Matt: And I really enjoyed that show about kind of the, and I'm going to spoil the plot here. It comes down to pay taxes when you're in a low bracket. And So I think that's very useful in itself and again, people can look that up, but all right so let's what's the punchline on this third
[00:15:42] Mike: So this is location matters where you. Which assets can make a difference on your taxes, or, I'm only paying the taxes you owe, trying to save as much as you can and taxes. So let me give you a for instance if I have a bond, an IOU, okay. And I'm making 5% of that's interest payments.
So I get a, I put in a hundred thousand dollars and I get $5,000 a year of interest payments. Okay. Those interest payments I'm going to. Because it's interest. So if I'm in a 24% tax bracket, instead of getting $5,000, I have to pay what $1,200 or so. Okay. So I only get less than 4,000, if so, that's an, if I have it just in a brokerage account, if I take the same IOU bond and I have it in my traditional IRA, when I get that 5,000 of interest, I do not pay any taxes.
[00:16:37] Matt: And so then that extra 1200 bucks that you're not paying taxes.
continues to grow at whatever interest rate you're getting overtime. Eventually you pay taxes, but that's the idea of the IRA is that you're getting that boost. Deferring the taxes and growing with interest.
[00:16:54] Mike: Exactly. So your interest payments and dividend paying. Our tax deferred or tax-free if they're in a traditional 401k, traditional IRA Roth 4 0 3 BS. Any of these kinds of tax advantaged accounts, the interest and dividends you get are not taxed. Okay. Maybe they're tax never taxed if an Roth, or maybe they're going to be taxed in the future.
So that's where the location. Of what you hold can be important now. So what do you hold where which types of assets do you hold? I just told you the bond example. So if you have high interest bonds, you want to put those in your tax free and tax deferred accounts for your point. It compounds, let that interest compound over decades and then eventually pay the taxes later on.
Okay. On the flip side, ETA, you just talked about ETFs, hold those in your taxable account. Long-term you know, oh, I'm going to hold the total us stock. In an ETF, just hold that in your brokerage account. Not too many interest payments and dividends coming off of that ETF. And it's just going to grow and compound and you get to decide when to sell it and take those capital gains.
[00:17:58] Matt: Yeah. Makes sense to me. And one of the takeaways that I'm having here, because I know a lot of this information is coming really fast to our listeners. Even the people who are listening on podcast and can hit that 15 second rewind. But I think the upshot that I'm getting here is there are lots of small things you can do.
Not really $10,000 savings here. It's a few hundred here, a few hundred there. That adds up. And so the idea is to package All these things together intelligently, and it really does get you in a position of saving thousands of dollars. Here's what we're going to do. Mike Morton.
We're going to take a very quick break for our radio listeners. We're going to end the podcast here. And when we come back in the next episode, we're going to talk about the rest of your grab bag of tips and tricks.
So we'll be back in just a minute.