Are you holding tax-inefficient investments in taxable accounts?

Not all investments are taxed the same way. Bonds generate interest income, which is taxed as ordinary income at your top marginal rate—potentially 37% federal plus state taxes. Stock index funds generate minimal taxable events and most gains are long-term capital gains taxed at 15% or 20%. REITs and high-dividend stocks generate income that's taxed every year whether you need the cash or not.

Where you hold these investments matters as much as what you hold. If you own bonds in a taxable brokerage account, you're paying ordinary income tax on the interest every year. If those same bonds were in an IRA, the interest would grow tax-deferred and you'd only pay tax when you take distributions in retirement—potentially at a lower rate, and decades later.

The tax-efficient approach: Hold tax-inefficient assets (bonds, REITs, actively managed funds, high-dividend stocks) in tax-deferred accounts like IRAs or 401(k)s. Hold tax-efficient assets (index funds, ETFs, growth stocks, municipal bonds) in taxable accounts.

How to check: Look at your most recent tax return. If you're seeing significant interest income or dividend income from your taxable brokerage account, your assets probably aren't located efficiently. Your CPA can see this on your 1099 forms. Your advisor should be structuring accounts to minimize it.

Is your advisor generating unnecessary capital gains through excessive trading?

Some investment strategies require frequent trading. If your advisor is actively managing your portfolio—buying and selling individual stocks, timing the market, or frequently rebalancing—they're likely generating short-term capital gains. Short-term gains (positions held less than a year) are taxed as ordinary income, not at the lower long-term capital gains rate.

Let's say your advisor generates a 10% return, but 4% of that comes from short-term gains taxed at 35%, and the other 6% is long-term gains taxed at 15%. After taxes, you're keeping about 7.5%. Meanwhile, an index fund that generates a 9% return with minimal trading and mostly long-term gains might leave you with 8% after taxes. The "lower return" strategy actually puts more money in your pocket.

The tax-efficient approach: Minimize turnover. Hold positions for at least a year to get long-term capital gains treatment. Rebalance using new contributions rather than selling appreciated positions. Use tax-loss harvesting to offset any unavoidable gains.

How to check: Ask your advisor for the portfolio turnover rate. If it's over 50%, they're replacing half the portfolio every year, which likely means significant taxable events. Look at your 1099-B to see how many trades generated short-term vs. long-term gains.

Are you paying taxes on mutual fund distributions you didn't ask for?

Mutual funds are required to distribute capital gains to shareholders at the end of each year. Even if you don't sell a single share, you owe taxes on those distributions. Actively managed mutual funds with high turnover can distribute significant gains—sometimes 5-10% of the fund's value in a single year.

Here's the frustrating part: you might have bought the fund in November, and in December it distributes a capital gain from sales the fund manager made months before you owned it. You didn't benefit from the gain (the fund price drops by the distribution amount), but you still owe the tax.

The tax-efficient approach: In taxable accounts, use ETFs instead of mutual funds. ETFs are structured in a way that allows them to avoid distributing capital gains in most cases. If you do use mutual funds in taxable accounts, choose low-turnover index funds that rarely distribute gains.

How to check: Look at the fund's distribution history. If it's regularly distributing 2-5%+ in capital gains each year, it's tax-inefficient. Your 1099-DIV will show capital gains distributions you were taxed on.

Are you missing opportunities to harvest tax losses?

Markets go up and down. When they go down, you have an opportunity to sell positions at a loss, realize the loss for tax purposes, and immediately reinvest in a similar (but not identical) asset to maintain your exposure. Those losses can offset capital gains, and any excess losses can offset up to $3,000 of ordinary income per year, with the remainder carrying forward to future years.

If your portfolio has been invested for a while and you've never harvested a loss, your advisor either isn't monitoring for opportunities or doesn't think it's worth the effort. But even in up markets, individual positions decline. A well-managed taxable portfolio should be harvesting losses regularly—not just in December, but throughout the year whenever opportunities arise.

The tax-efficient approach: Monitor taxable accounts continuously for loss-harvesting opportunities. Harvest losses throughout the year, not just in December. Build a "loss bank" that can be used to offset future gains from rebalancing, RMDs, or asset sales.

How to check: Ask your advisor if they've harvested any losses in your account over the past few years. If the answer is "no" or "I don't think so," you're leaving money on the table.

Are you rebalancing in taxable accounts when you could rebalance in retirement accounts?

Rebalancing—selling winners and buying losers to maintain your target allocation—is important for managing risk. But in a taxable account, rebalancing creates capital gains. In a tax-deferred IRA or 401(k), rebalancing has no immediate tax consequence.

If you have assets in both taxable and retirement accounts, the tax-smart approach is to do as much rebalancing as possible inside the retirement accounts, where it doesn't trigger taxes. Only rebalance in taxable accounts when necessary, and when you do, look for opportunities to use tax-loss harvesting to offset the gains.

The tax-efficient approach: Rebalance first in IRAs and 401(k)s. In taxable accounts, rebalance using new contributions (add money to underweighted positions rather than selling overweighted ones). Harvest losses to offset any unavoidable gains from rebalancing.

How to check: If your advisor rebalances your entire portfolio once or twice a year without distinguishing between taxable and tax-deferred accounts, they're not optimizing for taxes.

Are you holding municipal bonds in retirement accounts?

Municipal bonds pay interest that's exempt from federal income tax (and sometimes state tax). That makes them attractive in taxable accounts for people in high tax brackets. But in an IRA or 401(k), the tax advantage disappears—you're deferring tax-free income, then paying ordinary income tax on it when you take distributions. That's backwards.

If you want fixed income in a retirement account, you're better off holding corporate bonds or Treasury bonds that pay higher interest. Save the municipal bonds for taxable accounts where the tax exemption actually benefits you.

The tax-efficient approach: Municipal bonds in taxable accounts (for high earners). Corporate/Treasury bonds in retirement accounts.

How to check: Look at your IRA or 401(k) statement. If you see municipal bonds or muni bond funds, you're giving away the tax advantage.

Are you taking distributions from the wrong accounts first?

Once you're retired and taking withdrawals, the order in which you draw from accounts matters. Taking from a taxable account triggers capital gains. Taking from a traditional IRA triggers ordinary income. Taking from a Roth IRA is tax-free.

The conventional wisdom is to delay IRA withdrawals as long as possible to let money grow tax-deferred. But that's not always optimal. If you're in a low tax bracket early in retirement (before Social Security, RMDs, or pension income kicks in), it might make sense to take IRA withdrawals or do Roth conversions while your rate is low, even if you don't need the cash. Otherwise, you're forced to take large RMDs later at higher rates.

The tax-efficient approach: Model your tax situation over the next 10-20 years. Identify low-income years and use them strategically. Sometimes it makes sense to take IRA distributions or do Roth conversions early to avoid a bigger tax bill later.

How to check: If your advisor is telling you to "never touch your IRA until you have to," they're not thinking about tax optimization. The right answer depends on your specific income, tax rates, and timeline.

Are you ignoring the 0% capital gains bracket?

If your taxable income is below about $94,050 (married) or $47,025 (single) in 2024, your long-term capital gains are taxed at 0%. That means you can sell appreciated assets, realize the gains, and owe zero federal tax on them.

This is huge for early retirees or people in low-income years. You can "harvest" gains—sell appreciated positions, pay no tax, and immediately buy them back at the new higher cost basis. This resets the basis and reduces future taxes when you're in higher brackets.

Most people don't even know this bracket exists, and most advisors aren't monitoring for it.

The tax-efficient approach: If you're in a low-income year, intentionally realize capital gains up to the 0% bracket threshold. Lock in tax-free gains now rather than paying 15-20% on them later.

How to check: Look at your tax return. If your income is low and you didn't realize any capital gains, you missed an opportunity.

How much does this actually cost you?

Let's say you have a $3 million portfolio. If your investment strategy costs you an extra 1.5% per year in unnecessary taxes—through poor asset location, excessive trading, fund distributions, missed loss harvesting, and inefficient withdrawal strategies—that's $45,000 per year.

Over 20 years, assuming 7% growth, the difference between a tax-efficient strategy and a tax-inefficient one is over $2 million. That's money that could have stayed in your account, compounding for your benefit, instead of going to the IRS.

Tax efficiency isn't glamorous. It doesn't show up on performance reports. But it's one of the few things in investing you can actually control. You can't control market returns. You can control how much of your return you keep.

What to do about it

If you're seeing high turnover, short-term gains, mutual fund distributions in taxable accounts, municipal bonds in IRAs, or you've never harvested a tax loss, your investment strategy is probably costing you more than it should.

The fix isn't complicated, but it requires coordination. Your advisor needs to know your tax situation—what bracket you're in, what income you have from other sources, whether you're over NIIT or IRMAA thresholds. Your CPA needs to know what's happening in your investment accounts—when gains are being realized, what losses are available, how much income you need.

When both are working together, your investments get managed in a way that keeps more money in your account and sends less to the IRS. When they're not, you're paying taxes you didn't need to pay.

If you're wondering whether your investments are tax-efficient, let's review your accounts and see where you stand.