This is the third post in our tax-planning series. Last, Spencer wrote about smart charitable giving. Today: how your investments themselves can quietly cost, or save, you in taxes.
A client called me last spring with a question I hear more than people might think.
“I haven’t sold anything in my account all year. So why am I getting a tax bill?”
It’s one of those moments that’s easy to miss, and easy to fix once you know to look for it.
The tax bill nobody warned you about
If you own mutual funds in a regular, non-retirement taxable account, here’s something that surprises a lot of people: the fund itself can buy and sell investments inside the basket during the year. When it does, any gains get passed on to you as a capital gain distribution…and you owe tax on them.
You didn’t sell anything.
You don’t get any of the money.
You just get the tax bill.
It’s not a flaw in your account. It’s how mutual funds work. But it’s also one of the most common reasons we see people paying more in tax than they need to.
Why we lean on ETFs in taxable accounts
Exchange-traded funds (ETFs) are built a little differently. They generally don’t pass along those surprise capital gain distributions year after year.
For a client who doesn’t plan to spend the money in that account in their lifetime, that difference can compound. A smaller tax bill every year along the way. And because the asset passes to your heirs with a stepped-up basis, the gains you never paid tax on don’t get taxed on the back end either.
Same investment idea. Same growth. Just less paid in tax getting there.
When a down year actually works for you
We don’t celebrate down markets. But when they happen, there’s a small move worth knowing about: tax-loss harvesting.
If a holding has dropped in value, we can sell it at a loss and use that loss to offset taxable gains (or up to $3,000 against ordinary income). Then we reinvest in something similar, not identical, so you stay in the market.
You haven’t given anything up. You’ve just turned a paper loss into a real tax benefit.
A few questions worth asking
You don’t need to know all of this to be a good investor. You just need a planner who’s looking.
Some questions worth bringing up:
- What’s actually in my taxable account?
- Am I getting capital-gain distributions I didn’t know about?
- Have we ever harvested losses?
- Could anything be more tax-efficient than it is right now?
The bigger point
A portfolio can be doing well on the surface and still leaking value to taxes underneath. Every dollar that doesn’t go to the IRS goes somewhere else, toward retirement, toward family, toward generosity.
If you’d like a fresh set of eyes on what you actually own, and what it’s quietly costing you, let’s sit down and walk through it together.
Next in the series: Bain on tax planning for business owners.
Tracey Bryan, CFP®, CKA®
