Free Portfolio Tax-Efficiency Analysis

OBTAIN A FREE PORTFOLIO INCOME TAX-EFFICIENCY ANALYSIS

Legend Financial Advisors, Inc.^® (Legend) offers a Free Portfolio Tax-Efficiency Analysis that measures and assesses the income tax-efficiency of an investor’s existing investment portfolio.

Legend can help you understand the nuances of income tax-efficient investment asset allocations (asset location) and how investments are taxed.  In fact, most investment income taxation experts believe that managing money income tax-efficiently can result in 0.50% to 1.00% in additional investment return annually.

Primary Income Tax-Inefficiency Issues With Investment Portfolios:

Legend believes that it is important to build investment portfolios that are managed utilizing tax-smart asset location techniques [placing income tax-inefficient investments in IRAs, IRA rollovers, Roth IRAs and rollovers, 401(k) and 403(b) plans as well as Roth 401(k) and 403(b) plans, while placing income tax-efficient investments outside of the above-mentioned retirement plans.], which can potentially result in additional returns, without increasing risk. When managing investment portfolios, Legend's goal is to incorporate the most income tax-efficient investment vehicles and trades securities in an income tax-efficient manner.

Another important consideration is the income taxation of the underlying investments. For example, equity mutual funds are taxed differently than exchange-traded funds (ETFs) from an income tax standpoint. In fact, ETFs, depending upon their underlying taxation structure, can be taxed differently from an income tax standpoint even though they may own the same securities.  Essentially, the same can be said of mutual funds, depending upon which method of accounting is used by each mutual fund for income tax accounting purposes.

There are also significant income tax differences between ETFs and Exchange-Traded Notes. Closed-end mutual funds also can be taxed differently than other types of funds.

Furthermore, some mutual funds and ETFs send out 1099s to investors during income tax season whereas other funds send out K-1 partnership forms. These previously mentioned fund entities’ information generally refers to equity funds.

When utilizing foreign investments or possibly interest generating (debt investments) funds, which include fixed and variable interest rate securities, additional income tax considerations will need to be taken into account. However, this amount of situational income tax information for many investors can be too complex to understand.

Individual stocks can avoid many of the income taxation issues mentioned above if the turnover (buying and selling) of the individual securities within the investment portfolio is minimal and/or the selling of securities with gains are offset against those with losses.  However, certain individual securities, such as master limited partnerships, usually will generate K-1 income tax forms. Foreign securities, depending upon the type, can also cause income taxation complexity.

It is important to not make the mistake of utilizing average cost basis in computing the cost basis of the securities owned. Therefore, in the computation of their gains and losses, the amount of capital gains will increase the amount of income taxes to be paid unnecessarily.

The average cost basis is usually provided by the mutual funds themselves, if bought directly or via brokerage firms or custodians as a default method of calculating cost basis. This practice can be very income tax-inefficient. 

In order to minimize the negative effects of average cost basis, investors should use specific cost identification of the individual share lots of the securities purchased.  By doing so, when selling securities, investors can minimize the income tax-effect of the sale by utilizing higher cost basis share lots. As a result, share lots with larger gains will not be sold until a later date, thereby deferring income taxes into the future.

What Legend Will Do For You:

Given the complexity of minimizing income taxes when investing, Legend will evaluate existing investment portfolios for free via an income tax-efficiency scoring system, which evaluates how income tax-efficient the existing investment portfolio allocation is. Legend will also provide an investor with potential changes to alter the investor’s portfolio to increase their income tax-efficiency.

Legend manages client monies (assuming the investor retains Legend for Investment Management services.) in an income tax-efficient manner by constructing portfolios utilizing tax-smart asset location [placing income tax-inefficient investments in IRAs, IRA rollovers, Roth IRAs and rollovers, 401(k) and 403(b) plans as well as Roth 401(k) and 403(b) plans, while placing income tax-efficient investments outside of such retirement plans.], which can potentially result in additional returns, without increasing risk.  In addition, Legend utilizes income tax-efficient investment vehicles and incorporates income tax-efficient trading strategies, where possible.

Paying less in income taxes is smart. Therefore, when managing a client’s portfolio, Legend focuses on income tax-efficiency, where possible.