Tax Strategy When Building Your ETF Portfolio

By: Pete
Date posted: 12.06.2011 (11:25 am) | Write a Comment  (0 Comments)

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When building your own ETF portfolio, there are many things to consider. I would say that the most important is asset allocation as that will have a very high impact on your portfolio’s profile, how it reacts over time, etc. However, as important is the way that you manage your taxable income. Reducing the taxes to be paid can result in significant savings over time, especially if those savings can be invested for several years in the future. There are many different ways to get this done but let’s take a look at one simple way to do this.

If Possible, Keep All Income Generated By Your Investments In Non-Taxable Accounts

Most investors manage several types of investment accounts.but the two big distinctions are:

-Taxable Accounts
-Non-Taxable Accounts

In many cases, the taxes being avoided in the present will end up being paid at some point in the future when the money is withdrawn. Still, being able to pay later is a significant advantage. Why?

-Because the money can be reinvested for years and even decades without paying taxes
-Because your tax rate will likely be lower later in life as your income diminishes (after retirement).

Supposing that your retirement portfolio will include assets in both types of accounts, one important consideration is to avoid taxes (income and capital gains) in your taxable/cash accounts. How? Here are some tips:

Hold dividend payer ETF’s (or the higher paying ones) in tax-free accounts
When selling ETF’s for rebalancing purposes, be sure to do sales that will generate capital gains in tax-free accounts and ones that will generate losses in your cash/taxable account.

There are other considerations that we will look into in the future but for now, this first step could end up saving you thousands in taxes now, and make a difference of tens of thousands down the road.


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