Investment Tax Planning
Why we bark at taxes
There’s a constant tug of war between gains from investments and losses due to taxes. Taxes are part of investing, but too often they become an afterthought—dare we say it?—the tail wagging the dog. At Rain Dog, we build your plan so taxes are managed by design, not surprise.
Investment tax planning
Smart tax work isn’t about chasing loopholes—it’s about integrating tax considerations into every part of your financial plan. We use as much care in designing for taxes as we do in designing for your investment goals.
Here are some of the areas we consider.
Direct indexing holds individual stocks to create additional opportunities to realize tax losses. For high-net-worth households, direct indexing is often presented as a cornerstone of tax strategy. In our strategic portfolio design, Rain Dog considers direct indexing as one of many tax-management tools, and we weigh it against its interactions with other tax-management tools.
We consider how direct indexing interplays with investment choices, asset allocation, tax-efficient asset location, tracking error, and ability to provide sustained after-tax value over time. We also consider the effect it has on increased portfolio management fees.
For any given client, we can evaluate and implement direct indexing if it improves after-tax results. As a fiduciary, we have a responsibility to avoid recommending it when it would be ineffective or when it would create unnecessary expense.
For more on our experience with direct indexing, see our Field Note: The Case Against Direct Indexing.
Some advisors will apply rules of thumb such as, “Your highest growth assets should be in your Roth account”; “income-producing assets should be in your tax-deferred account”; and so on.
This is well-intended but not very effective. The truly tax-efficient location of your assets depends on your unique circumstances: the amount of your total assets; percentage of assets you have in accounts with different tax statuses; how close to retirement you are; your near-term cash needs; your plans for Roth conversions; your strategy for handling required minimum distributions (RMDs); the cost basis of your taxable assets; and many other factors that are unique to you.
For more on our approach, see our Field Note: The Value of Asset Location.
One reason Rain Dog tends to choose index funds is that they are usually tax efficient. Index funds tend to have low portfolio turnover compared to actively managed funds.* With low portfolio turnover, only a small percentage of your gains are taxed each year, and your taxable investments can grow almost as if they were tax-deferred rather than taxable.
Growth is good—but growth that respects the tax code is better. We design for both.
*Sources: “Turnover ratios and fund quality,” Investopedia, retrieved 1/24/2024; “US Mutual Fund Turnover and Returns, 1991-2020,” Gene Hochachka, SSRN, December 10, 2021.
We monitor your account for opportunities to harvest tax losses when it is tax advantageous to you.
Rebalancing is a valuable investment technique, but taxes can undermine investment performance if rebalancing is not performed with tax consequences in mind. Naive rebalancing can result in short-term capital gains, and too-frequent rebalancing can erode after-tax investment gains. When we rebalance, we do so with tax consequences in mind.
A backdoor Roth conversion can be one your most powerful tax planning tools. Our Investment Forecast Model simulates a variety of future tax environments—based on your specific income, assets, and planning horizon—and we design a tax-efficient Roth conversion strategy for you.
Some individuals and couples will experience a few years of relatively low employment income as they wind-down full-time employment, or as one partner retires earlier than the other. Those years can provide a valuable tax-management corridor in which to transition your assets to be tax-efficient during retirement. In other words, we can use a tax-efficient process to arrive at a tax-efficient destination.
We hear horror stories of advisors switching clients to new portfolios without considering the tax consequences. Clients can be left with large, unexpected tax bills. At Rain Dog, we fully consider the tax implications and tax-reduction possibilities around such changes.
First, we evaluate whether the benefits of a proposed portfolio change will outweigh the tax consequences. Poor tax planning can wipe out investment gains, and we never want that to happen.
Second, we evaluate the most tax-efficient way to make the desired changes. We evaluate the transition’s timing and the extent to which changes can be made in your tax-preferred accounts without creating tax consequences in your taxable accounts.
Third, if we find that increasing your tax bill in the short term will improve your financial situation over the long term, we will communicate that to you and be sure you agree before we proceed. We don’t want you ever to be surprised by an unexpectedly large tax bill.
Different size estates call for different kinds of tax planning. In addition to the total size of your estate, the specific form in which you leave your assets will affect how much your heirs receive after they pay their taxes. We evaluate that as part of your investment planning. We also consider alternative means of transferring wealth to your heirs, which is especially important for residents of Washington state.
The investment planning tools used by many advisors do not fully consider the effects of taxes on investment growth, or, in some cases, consider taxes at all. Rain Dog’s Investment Forecast Model thoroughly integrates tax consequences into its investment forecasts.
We believe in paying our fair share of taxes—we just don’t believe in paying more than necessary. You should feel as confident in your tax plan as you do in the rest of your finances. Get in touch, and let’s see whether we can take a bite out of your taxes.
