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December 12, 2023 at 04:21 PM
What You Need to Know
- Taxable accounts can provide more flexibility, Benz noted.
- She developed 14 model portfolios for different retiree and pre-retirement investors.
- With the right investments, taxable accounts can be almost as tax-efficient as 401(k)s and IRAs, she said.
Even though taxable investment accounts lack the powerful tax breaks unique to formal retirement vehicles, pre-retirement savers and retirees alike may benefit from allocating funds to tax-efficient, non-retirement portfolios.
While retirement vehicles like 401(k) accounts and IRAs provide various tax advantages, such as deductions on contributions, tax-free withdrawals and tax-deferred compounding, they can also limit flexibility, Christine Benz, Morningstar’s director of personal finance and retirement planning, noted in a recent column.
Penalties for early withdrawals, caps on contribution amounts and limited investment choices can constrain retirement account investors, said Benz, who has developed several suggestions for tax-efficient model portfolios for those who’d like to tap into the “maximum flexibility” available in taxable accounts.
Besides the ability to save as much as possible, withdraw funds without penalty and invest in virtually anything, taxable accounts also offer supersavers another option once they’ve maxed out their tax-sheltered retirement accounts, she said.
“And if you’re careful with investment selection, your taxable account can be nearly as tax-efficient as your retirement accounts,” Benz wrote.
Maxing out those tax-sheltered IRAs and 401(k)s remains good advice, Benz noted in an interview with ThinkAdvisor recently.
“Most investors do start at least with the tax-sheltered accounts,” and they should, given that advantages like deductions on contributions to traditional IRAs and tax-free withdrawals from Roth accounts “are very valuable things,” she explained.
Short- or intermediate-term needs, such as saving for a down payment on a home, remodeling projects or a lake house, are another use case for investing in non-retirement funds, Benz noted.
When Benz does portfolio makeovers, she finds investors often have been stuck with tax-inefficient holdings, so she aimed to address that perennial problem.
Model portfolios for tax-efficient investing in taxable accounts aim to limit dividend and epecially capital gains distributions, she said. Tax-managed mutual funds, index funds and exchange-traded funds can become key components in such portfolios.
Since mutual fund holders are in the throes of capital gains distribution season, the tax-efficient model portfolio suggestions might light a fire under some investors, she said.
Benz organized her model portfolio suggestions to match different investors’ life stages and investment styles. The portfolios comprise Morningstar Medalist mutual funds and ETFs, and are all oriented toward retirement, she wrote.
The Morningstar retirement planning expert said Morningstar provided the portfolios for educational purposes to illustrate sound tax-management techniques for individuals and isn’t selling tax-efficient model portfolio products.
