The Case for Tax Adjusting a Portfolio

All dollars are not created equally; some are worth more than others. Why? Because some money can be used without incurring taxes, while other money must be taxed at either capital gains or ordinary income rates.

One of the toughest dilemmas I wrestle with is whether to consider future tax liabilities from unrealized gains in the portfolio and taxes from withdrawing from traditional retirement accounts. It’s a very important issue for which there has been little media coverage.

To put it concisely, Roth dollars are the client’s most valuable money, followed by taxable money, with traditional tax-deferred dollars being the least valuable.

The simple example

Let’s take a simple example of a $1 million portfolio.

This client’s asset location appropriately minimizes taxes. The 50% allocation to stocks was their target. But all this money isn’t theirs. Assume the tax-deferred money has a zero basis and the taxable portfolio has a $100,000 long-term gain. Further, say the client is in the 37% ordinary-income marginal tax bracket (state and federal) and the 20% long-term capital-gains rate.