10 tax saving strategies the financial pros use

It's not what you make, it's what you keep!

I believe John Wayne gets credit for that line, and if you think about it, this also rings true in today's tax and investment landscape.

Often we see advisers and investors only looking at the investment, and not looking at the tax consequences. While you never want the tax tail to wag the dog, efficient taxable portfolio managers do employ strategies to increase what is most important — after-tax returns.

Here are 10 tax saving strategies to save money on taxes on investments.

1. Long-term cap gains are much better than short-term

If we look at the current capital gain tax rates, we can clearly see that we want to take long-term cap gains rather than short term. Short term capital gain tax kicks in when you sell something at a gain, but you have not held that position for more than one year, versus long term which is held over one year.

The difference can be quite substantial. For those in the 10% and 15% federal income brackets, they will pay no capital gains tax! Someone in the 25%-35% bracket will only pay 15%, a potential 40%-57% decrease in overall tax.

And those in and above the 35% bracket will only pay 20%, a 43% decrease. So as you can see, experienced taxable portfolio managers can customize the tax trading to each client and can create more value beyond the portfolio.

2. Tax loss harvesting

So what to do when you want to take those gains? One strategy is to specifically sell positions held at a loss, to offset the capital gain from the sale of the appreciated asset. This is called tax loss harvesting. Losses will offset the gains.

3. Tax swap

Those concerned about selling and maintaining exposure to a particular stock/etf/mutual fund could execute a "swap" strategy.

An example: You currently hold Ford stock at a loss but need to sell to offset a short-term gain you generated in Apple; you can buy GM.

Since Ford and GM are both in the same sector and both are auto makers, they will usually have a high correlation to each other. However, a wise portfolio manager would not execute such a move around high volatility events like earnings, new product release, etc.

4. Ordinary vs. qualified dividends

Aren't all dividends the same?

No, all dividends are not created equally. Some dividends are ordinary while some are qualified.

What does that mean? Ordinary dividends are taxed at your highest marginal rate, while qualified dividends are taxed at much more favorable long term cap gains rates.

This tax treatment is derived specifically from where the companies are domiciled and do business as well as the holding period (60 days before and after the dividend). Qualified dividends are taxed at the same long term cap gains rates like we discussed above.

5. Tax-free income

Yes, that's right, I said it: Tax free income!

I find it astounding many investors and even some financial advisers fail to utilize tax-free bonds in their overall portfolio (should their goals and objectives call for it, of course).

I've even seen human advisers and robo-advising alike using the least tax-efficient set of bonds, therefore adding the tax drag on the portfolio.

Here is how the preferential tax treatment works: Joe lives in California. Joe purchases a California municipal bond. The interest that bond pays to him every month will not be taxed by the state, but also will not be taxed federally or locally as well! Triple tax exempt is the term to be exact.

Now if Joe purchased a Pennsylvania municipal bond, he would not pay federal tax (the biggie), but he would pay California state income tax.

6. Lower turnover ratio

However investors decide to get exposure to the areas they want in their portfolio, one thing remains the same: Low turnover ratio is a good thing!

Turnover ratio is the amount of buying and selling in the portfolio, mutual fund or ETF in a given year. If said portfolio has a 94% turnover ratio, that means on average if the fund has 100 stocks, 94 are bought and sold each year.

Now, is that a good thing? Well, maybe if the fund is buying better stocks…right?

But with everything, there is a cost, and not only trading costs. Remember what we learned earlier: if those 94 stocks have a profit we will be paying short-term cap gains!

We don't want that, so make sure to keep an eye on the turnover ratio. By law, mutual funds are required to distribute over 90% in gains, so sometimes people who have mutual funds in taxable accounts or trusts are paying much more in taxes than what they should be paying.

7. Portfolio management costs and commissions are tax deductible

Remember, the investment management fee and any trading commissions you pay are deductible.

Unfortunately, the expense ratio — the internal cost of running a mutual fund or ETF — is not deductible. Turnover and expense ratios are some of the most important things to look at.

8. Asset location

Most advisors talk about asset ALLOCATION, but where they may fail is the asset LOCATION.

For investors who want to gain exposure to certain sectors that only create ordinary income (like Real Estate Investment Trusts, for example) one would utilize the asset location of the retirement account instead of the taxable account, thereby still gaining exposure to that sector but not having to worry about the inefficient tax treatment.

9. Have kids and want to save for college? Use a 529 Plan

Instead of having a simple savings account and paying taxes every year on gains and income, if the goal is to use the money for higher education, look into a 529 plan.

A 529 plan allows you to invest funds for children and not only skip the tax bill each year on cap gains and investment income, but also never pay any tax as long as the funds are used for higher learning. Some states give you a tax deduction as well.

10. Defer, defer, defer

In situations where individuals are in high tax brackets now but will be considerably lower in the future, deferring could make sense.

Annuities can be used in many ways and act as a tax shelter to defer the inevitable. In a fixed, fixed index or variable annuity, you do not pay any tax on cap gains, income or distributions each year inside of the annuity.

However, when you take the money out, your gains will be taxed at ordinary income rates. So although it is a good way to defer taxes you do still pay the ordinary tax rates at a later date.

Which annuities to use and stay away from is a whole other topic for discussion.

Even after using these strategies, if things are going well you're likely to still have a tax bill of some sort. There are some things a man (or woman) just can't run away from.

I believe John Wayne gets credit for that line, too.

Dennis Notchick, CFP is a Registered Investment Advisor Representative and Certified Financial Planner with Safeguard Investment Advisory Group (www.safeguardinvestment.com) in San Diego, Calif.