Around 158 million or 61 percent of Americans report owning stocks—the first time the annual average has breached the 60 percent mark since 2008. Regardless of the asset, investing is unparalleled in empowering financial futures.
It is a journey that promises wealth accumulation, financial security, and the fulfillment of your dreams. As a young investor, your path to financial success will not only require smart investment choices but also innovation and a mastery of tax efficiency.
With time on your side, you have a unique opportunity to leverage strategic tax planning to supercharge your wealth-building endeavors. You can attain this through the five tax-efficient and innovative strategies detailed below.
1. Invest in a Roth IRA Conversion Ladder
In its survey of almost 1,300 Americans, MagnifyMoney found that tax-advantaged retirement accounts are the most popular investment accounts overall, with 31 percent of GenZers having them.
Fidelity Investments data also show a remarkable increase in IRA adoption among young people in recent years. Signing up with an app only takes a few minutes, after all, not to mention there are near-endless financial topic resources available for instant access.
Of course, the benefits go way beyond that, especially when you invest in a Roth IRA conversion ladder. This innovative and tax-efficient strategy involves converting funds from a traditional IRA (or 401(k)) into a Roth IRA over time to manage tax liabilities in retirement.
First, contribute to a traditional IRA or 401(k) while you’re young and likely in a lower tax bracket. As you may know, a traditional retirement account provides an immediate tax deduction. In retirement or a period of lower income, you can start converting a portion of your traditional IRA or 401(k) into a Roth IRA. These conversions are considered taxable income, so you can minimize the tax impact if you do it strategically during lower-income years.
Note that there’s a five-year waiting period for converted funds in a Roth IRA to become tax-free. By starting early, these conversions can be available for tax-free withdrawals in retirement. Once you reach that age, you can withdraw the converted funds (and any earnings) with zero taxes, as long as you adhere to the five-year rule. This technique allows for tax-efficient income planning during your twilight years.
Another key advantage of this strategy is the flexibility that comes with it. You can control the timing and amount of conversions to optimize your tax situation in retirement.
As a young investor, a Roth IRA conversion ladder is particularly advantageous if you anticipate climbing the tax bracket ladder in retirement. It will allow you to lock in today’s lower tax rates and potentially enjoy tax-free withdrawals in the future. However, consulting with a financial advisor is vital in tailoring the strategy to your financial situation and goals.
2. Implement Tax-Loss Harvesting
In tax-loss harvesting, you strategically sell investments that have experienced losses to offset gains in your investment portfolio. There are at least three reasons you should consider this tax-efficient and innovative strategy.
First, tax-loss harvesting can help minimize your tax liability. You can offset taxable gains from other investments using these losses when you sell investments at a loss. That means you’ll pay less in capital gains taxes, allowing you to keep more of your investment returns.
Second, it lets you maintain your investment exposure while optimizing your tax situation. After selling the losing investment, you can reinvest your gains in a similar but not identical asset to stay in the market and potentially benefit from future proceeds.
Third, you have a longer investment horizon when you invest young, so tax-loss harvesting can be particularly powerful. By consistently implementing this strategy over time, you can accumulate substantial tax savings that can compound and grow with your investments.
Joining online communities is a great way to learn more about tax-efficient and innovative investing strategies for young people. You will meet experienced investors and financial experts dishing out valuable insights and even practical advice, such as how to choose a digital platform providing secure transactions.
3. Hold Investments for the Long Term
The tax code provides preferential tax rates for long-term investments. In the United States, for example, assets held for over one year are typically subject to lower capital gains tax rates than short-term investments. These lower rates can significantly reduce your tax liability on investment gains.
For young investors, this means considering a long-term investment horizon. An example of a tax-efficient and innovative long-term investment for young people is investing in a Health Savings Account (HSA). An HSA allows individuals to save for future medical expenses while enjoying unique tax advantages.
While investing in a Health Savings Account may not be considered a particularly innovative investment strategy on its own, they are primarily designed for healthcare savings and are typically associated with tax advantages. However, what can be innovative for young investors is how they strategically use an HSA as part of their overall financial plan.
The innovation lies in the creative approach to maximizing the HSA’s benefits. For instance, young investors can invest their HSA funds in growth-oriented assets like stocks or index funds instead of just holding them in a low-yield savings account. By doing so, they can potentially see their HSA balance grow over time, allowing them to cover future healthcare expenses, including those in retirement.
Moreover, young investors can consider using the HSA as a supplemental retirement savings vehicle. Once they turn 65, they can withdraw funds from the HSA for non-medical expenses without penalties (though income tax would still apply). This dual-purpose use of the HSA can be seen as an innovative strategy for young investors looking to combine healthcare savings with long-term wealth accumulation.
4. Invest in an ESG Fund
Environmental, Social, and Governance (ESG) funds focus on companies that prioritize sustainability, ethical practices, and social responsibility. They align with the values and preferences of many young investors concerned about environmental and social issues.
From a tax-efficiency standpoint, ESG funds may be structured to reduce capital gains distributions, which can help investors reduce their tax liabilities. Additionally, some governments provide tax incentives or benefits for investments in ESG-related initiatives, further enhancing the tax efficiency of these funds.
The integration of ESG criteria into investment strategies is an innovative strategy for any young investor, allowing you to both grow your wealth and contribute to positive social and environmental outcomes. ESG funds offer a forward-thinking approach to investing that resonates with the values of many young individuals while potentially providing long-term solid returns.
5. Optimize Your Asset Location
Asset location optimization is an innovative strategy you can employ to enhance your wealth-building efforts. This approach involves strategically placing various types of investments across different account types to maximize after-tax returns.
One key advantage is its ability to enhance tax efficiency. By allocating tax-inefficient assets, such as actively managed mutual funds or high-dividend stocks, into tax-advantaged accounts like IRAs or 401(k)s, you can minimize the annual tax burden on these investments, promoting more efficient long-term growth.
Furthermore, asset location allows you to capitalize on time as a valuable asset. With a longer investment horizon ahead of you, you can place high-growth, high-risk assets like equities in taxable accounts. This positioning sets you up to benefit from preferential long-term capital gains tax rates when you eventually sell these assets, which are typically lower than ordinary income tax rates.
The strategy also provides flexibility, enabling adjustments to your allocations as your financial circumstances change. You can adapt your asset placement to align with your career progression or significant life events such as marriage or home ownership, optimizing your tax situation accordingly.
Lastly, optimizing asset location contributes to your future tax diversification. Creating a mix of tax-free, tax-deferred, and taxable accounts offers you options for managing taxes in retirement.
As you embark on your investment journey, stay informed about changes in the investment landscape and tax laws and talk to a financial advisor or tax professional to tailor these strategies to your financial situation. By proactively managing your investments, you can keep more money working for you and achieve your financial goals sooner.
