5 Ways to Be a More Tax-Savvy Investor in 2024

Key Takeaways

• Investors can up their game in 2024, taking advantage of all the tax-sheltered receptacles.
• If you are holding anything that has a heavy year-to-year tax cost, try to silo those investments inside of tax-sheltered accounts and keep your taxable slots for investments that are more tax-efficient.
• Appreciated securities, especially in a taxable brokerage account, can be handled in a tax-efficient way by donating either directly to a charity or to a donor-advised fund.
• Ideally, a year or two before you retire, get a second opinion on your retirement plan.

Susan Dziubinski: Hi, I’m Susan Dziubinski with Morningstar. Managing an investment portfolio with an eye toward taxes is one of the best ways to improve your take-home investment returns. Joining me to discuss five ways investors can improve their tax games in 2024 is Christine Benz. She is Morningstar’s director of personal finance and retirement planning.

Nice to see you, Christine.

Christine Benz: Hi, Susan. Great to see you.

Contributions to Tax-Sheltered Accounts

Dziubinski: So, the first strategy that you think investors should consider relates to their contributions to tax-sheltered accounts. What do they need to know?

Benz: If they want to up their game in 2024, taking advantage of all the tax-sheltered receptacles that they have is a great way to do it. Many people have company retirement plans and IRAs in their toolkits. You might consider a couple of other contribution types. One would be to a health savings account. If you’re covered by a high-deductible healthcare plan, and you are qualified to contribute to an HSA, that can be a really nice way to set aside additional funds. You can use those funds, of course, to cover your healthcare expenses. But if you want to really take advantage of the tax benefits long-term, you can use non-HSA assets to cover your healthcare expenses as you incur them and let those HSA assets grow. So, take a look at that if you’re covered by a high-deductible plan.

Another account type that might be appropriate for supersavers, people who are maxing out everything that they possibly can, would be to take a look at whether your company offers what are called aftertax 401(k) contributions. There’s a lot of confusion about what these are, but these are essentially contributions that you can make of aftertax dollars. And those contributions are on top of whatever the baseline contributions are for company retirement plans. So, in 2023, for example, it’s $22,500 if you’re under 50; $30,000 if you’re over age 50. With these aftertax contributions, you’re actually able to take your all-in contributions, including your own contributions and your employer contributions, up over $60,000. So, this is something—obviously, you need to be a very high-income person, heavy-saver—but this is something to investigate because many of these plans that offer aftertax 401(k)s also offer what are called in-plan conversions. So, what that means is if you contribute aftertax dollars to the plan, you can convert automatically in-plan to Roth. And so, periodically, you can just send money over to the Roth column, that means that there really is no tax due, and you can enlarge the amount that you have in Roth accounts. So, sometimes this is called the mega backdoor Roth IRA, but it’s a really nice option. And I’m happy to see that plans are increasingly offering the aftertax 401(k). Now, I think something like 30% of large employers are offering aftertax 401(k)s.

Asset Location

Dziubinski: Now, you also think this is a good time to check up on which types of investments you hold in which account types. Why now, and what should people really know about what you refer to here as asset location?

Benz: Right. Asset location has always been an important concept. But the thing that has, I think, kind of lit a fire under a lot of us to get more serious about it is that income distributions are now higher because interest rates are higher. So, it’s not unusual to see a 4% yield or a 5% yield on a cash account today. And I think when yields were lower, it was easy to say, “Who cares?” But now that yields are higher, I think it really makes sense to be deliberate about what you’re keeping in your taxable account and what you’re keeping in your tax-sheltered account. So, if you are holding anything that has a heavy year-to-year tax cost, so any high-income producer, you want to try to silo those investments inside of tax-sheltered accounts and keep your taxable slots for investments that are more tax-efficient. So, a great example would be the broad market equity exchange-traded fund, really quite ideal from the standpoint of reducing the tax drag from year to year. Municipal bonds in the taxable account might make sense for higher-income people who want to have safer assets inside their taxable brokerage account. So, take a look at that, see if you might not make some tweaks there to make sure that you are being as tax-efficient as possible.

Secure Act and Inherited Retirement Accounts

Dziubinski: Now one of the most significant aspects of the Secure Act, which passed through Congress a few years back, relates to inherited retirement accounts. What do people need to know about that. and how might that affect their beneficiary designations?

Benz: It’s something to keep an eye on. Secure Act and Secure 2.0 both tweaked the rules related to inherited IRAs. And the big headline is that the old stretch IRA, which let beneficiaries stretch their distributions over their lifetimes, has gone away for a lot of people who might inherit IRAs. So, if you haven’t looked at this recently and you have an estate plan with beneficiaries for your IRA, it’s worth checking back—just saying, “Does this make sense? Does the way that I have this set up make sense?” There aren’t a lot of perfect workarounds for the way that the old stretch IRA worked, but it’s, I think, an impetus among perhaps other life changes that you might have going on to revisit your estate plan and, in turn, those beneficiary designations. Because this is a pretty big deal for people who had the plan of, “Well, my young person in my life is going to inherit this IRA and be able to take advantage of that tax benefit for many years.” May not be the case.

Can You Get Tax Breaks From Investments?

Dziubinski: Now, with so many taxpayers these days claiming the standard deduction, many investors may think that they won’t be able to get any sort of tax break from charitable giving, but you think there are some ways you can earn some tax breaks with investments. Walk us through those.

Benz: The main one I would look at is if you have appreciated securities, especially in a taxable brokerage account, donations of those securities either directly to charity or to a donor-advised fund, which in turn can make those charitable disbursements, can be a really tax-efficient way to handle those positions, especially if you have highly appreciated positions—employer stock is a good example—that are adding risk to your portfolio, that’s a really attractive strategy to consider. And it’s a way to earn a tax break. The idea is that you’re being really deliberate about when you’re making those charitable contributions of appreciated shares, you’re donating enough to get yourself over that standard deduction threshold so that in at least a year or a few years, you’re an itemizer. You’re able to take advantage of itemized deductions. You’re bunching those deductions. So, that’s one strategy available to anyone who has appreciated positions in their taxable account.

Another strategy that would be only open to people who are age 70.5 or above would be to look at the qualified charitable distribution, where you are donating a portion of your IRA directly to charity up to $100,000, and that amount is getting inflation-indexed starting next year in 2024. For 2023, it’s $100,000. But you can be a much smaller giver and still benefit from that QCD. The idea is that that you’re directing your provider to make that charitable distribution and make sure that you are documenting that contribution. But that will tend to be more effective than pulling the money out of your IRA, moving it to a brokerage account, writing a check, and then deducting it on your tax return. It tends to give you a bigger tax benefit.

How to Help Reduce Tax Drag in Retirement

Dziubinski: And then, finally, for people who are approaching retirement, what kind of strategies can they employ to help reduce that tax drag in retirement?

Benz: A couple. I am a big fan of getting some help on your retirement plan before you kick it off. So, ideally, a year or two before you retire, just get a second opinion. I know we have a lot of people who are very into creating their own financial plans, which is wonderful. But just get another set of eyes on your plan, on your planned withdrawal rate, your planned withdrawal system, but also the sequence that you’re using to spend from your accounts. That advisor, assuming he or she is tax-savvy, should be able to give you a sense of, “Well, OK, in this year you should pull from this account, leave this one alone,” and so on down the line. And you’ll kind of have a plan for the whole of your retirement.

And then the other thing to explore, especially for those early years of retirement, is whether you can take advantage of some strategies to potentially reduce your tax bill over the whole of your retirement. So, these are like the postretirement, prerequired minimum distribution years, phenomenal period of life to strategize about whether Roth conversions, converting traditional balances to Roth, might make sense, or potentially taking advantage of this qualified charitable distribution that we just talked about. The good news is that with the RMD age generally moving out, that widens the window for a lot of people who are, say, retiring in their mid-60s. They won’t be subject to RMDs until early 70s. It’s a great time to take advantage of those strategies that can potentially reduce your tax bill over your retirement.

Dziubinski: Christine, thanks for your time today and these tax tips. We appreciate it.

Benz: Thank you so much, Susan.

Dziubinski: I’m Susan Dziubinski with Morningstar. Thanks for tuning in.

Watch “5 Financial To-Dos for Investors in Q4 2023″ for more from Christine Benz.