If it’s April, taxes are on the minds of most Americans. Based on decisions made throughout the prior calendar year, investors might be caught with a nasty tax surprise and need to write a large check to Uncle Sam. We consider your taxes daily to avoid these surprises at Hill Investment Group. Practices we implement, like tax loss harvesting and asset location (tax-inefficient asset classes in tax-deferred accounts), can meaningfully reduce the taxes an investor may owe annually. However, we are talking about one of the most impactful practices today: investing in ETFs rather than mutual funds.

ETFs and mutual funds are two types of investment vehicles and are simply different ways of holding a group of underlying securities like stocks or bonds. Most investment strategies can use either structure to execute their investment strategy. For example, Dimensional Fund Advisors and Avantis Investors, two companies we invest with, have both a mutual fund and an ETF for their US Small Value strategies. For each firm, the strategies are run the same way. However, they have a different legal structure that, in turn, has different tax consequences. 

ETFs rarely distribute capital gains at the end of the year because of the way they rebalance and trade.

On the other hand, mutual funds almost always distribute some capital gains. The table below outlines the capital gain distributions for four specific funds in 2022.

Both the mutual funds distributed ~5% of their value in capital gains, whereas the ETFs did not distribute any. This means that investors in the mutual fund owed about 1% (assuming a 20% capital gains tax rate) in taxes to the government. For every $100,000 invested in the small value strategy, they owed $1,000 in taxes this April. Investors in the ETF, the same strategy but with a different legal structure, owed $0 in taxes this April.

By investing primarily in ETFs across our models, we avoid capital gain distributions for our clients in those funds and meaningfully reduce their tax bills yearly.

Let me know if you have questions or comments about this or any other investment-related topics by emailing me at: zenz@hillinvestmentgroup.com.

Information presented is for educational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies.  Investments involve risk and unless otherwise stated, are not guaranteed.  Be sure to first consult with a qualified financial adviser and/or tax professional before implementing any strategy discussed here. Past performance is not indicative of future results.

Around this time of year, taxes are near the top of just about everyone’s to-do list. At Hill Investment Group, we think about taxes every day of the year, working to maximize our clients’ after-tax returns. That means we not only try to maximize the returns in our clients’ portfolios but also limit the amount of money they have to pay in taxes.

Some of you may have already filed your taxes, and good for you. For those that have not already filed, below we share a few tips you can use to hopefully reduce the amount you send to Uncle Sam for 2021.

Contribute to your IRA: Saving in a traditional IRA is one of the simplest ways to reduce taxes. You can contribute up to $7,000 to a traditional IRA (if you are over age 50) and count it as a 2021 contribution to potentially reduce your income.

Contribute to a Health Savings Account: If you are covered under a high-deductible healthcare plan, a family can contribute up to $8,200 (if the owner is over age 55) to a Health Savings Account (HSA) and count it as a 2021 contribution. This is an often-missed opportunity. We were told by one CPA that if you can only contribute to your HSA or 401(k), they would pick the HSA for the tax benefits – quite an endorsement.

Charitable Contributions: Married couples can deduct up to $600 of cash charitable contributions even if they take the standard deduction. So, although you may not have other deductions, be sure to keep track of those cash gifts you made in 2021.

As with all tax planning, we recommend you connect with your accountant or CPA to get more information on your specific situation.

There has been a lot of talk about the House Ways and Means Committee’s tax proposal. Whether in The Wall Street Journal or from Take the Long View podcast guest, John Jennings’ break down of the good, the bad, and the ugly, speculation is all over the place. As a client of Hill Investment Group, you can rest assured that we are planning for all of the potential iterations.

Below we’ve reviewed the most relevant points for our clients. Have questions? Feel free to reach out to us to discuss how the potential changes may affect you. Set up a time to talk here.

Have questions? Feel free to reach out to us to discuss how the potential changes may affect you. Set up a time to talk here.