Work With a Financial Advisor to Understand the Tax Implications of Your Investments

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Contributor, Benzinga
July 5, 2022

Using a financial advisor is one way to invest well, and they can help you. But before talking with one, it can be useful to understand the basic tax implications of various investment and asset types. By working with a financial advisor who understands how tax laws affect your investments, it's possible to achieve profitable investing while simultaneously reducing your potential tax liability.

Here are some of the tax implications that you need to be aware of related to investments. 

Tax Implications of Investments Made by a Financial Advisor

It’s important to consider both risk and tax implications before making an investment. Financial advisors — like those recommended by Datalign Advisory's platform — will take time to explain how your federal and state taxes may be affected by various investment options.   

For example, your financial advisor may explain that the investments in your current portfolio are better suited for a different tax bracket and advise you to make some changes, or your financial advisor may inform you that you can offset the taxes you owe on capital gains through tax-loss harvesting. By selling losing investments at the end of the year to generate capital losses to offset capital gains, you can recover at least a portion of your losses by reducing tax obligations.

Understanding the basic tax concepts of various investment and asset types is not only smart, but will help you be a more active proactive investor. Here are some points that you should understand when speaking to your financial advisor.

1. Municipal Bonds: One of the best tax-advantaged investments you can make is in municipal bonds. That’s because you pay no federal tax on the interest earned on these bonds. You may also avoid local or state taxes on the interest depending on where the bonds are issued. Unlike corporate bonds, municipal bonds are a great addition to your portfolio if you're looking for a tax-advantaged investment.

2. Annuities: This investment product also provides tax benefits for investors, and your financial advisor can speak with you about how to best use it. For instance, you earn interest, dividends or capital gains tax-free on an annuity until you begin making withdrawals. At that time, your advisor can help you continue to enjoy the tax advantages by timing the withdrawals. During this time, you may be able to withdraw money from your investments at a lower tax rate because you’re likely in a lower income tax bracket.

3. Mutual Funds: Investing in mutual funds is a great way to diversify your investments, but you may be able to reduce your tax burden by investing in a specific type of mutual fund. For instance, active mutual funds trade in and out of different positions, which helps the fund make money. But when it does, those capital gains are passed onto you along with the tax obligations. You can still invest in mutual funds and reduce your tax burden by looking to index funds or exchange-traded funds. These types of funds may reap the same or similar return on investment, but because of their buy-and-hold strategy and indexing (which are designed to include gains in the share price), they may help you avoid capital gains distributions. These funds reap the same return on investment, but because they turn over less frequently, they will help you avoid those capital gains distributions.

4. Tax-Loss Harvesting: Sometimes you might want to sell a stock to offset a gain, but you want to do it in a way that gives you the tax advantages you seek. You cannot sell a stock for a loss that you purchased within the past 31 days, and if you have owned the stock for longer than that and sell it, you cannot repurchase it or any other “substantially identical” stock for 31 days. This transaction is called the wash sale period, and your financial advisor should advise you on how to use it to take to properly sells stocks to offset gains. Taking advantage of tax-loss harvesting may require you to wait at least 31 days (the "wash sale period"), and your financial advisor can advise you how to properly structure and time your investment sales to ensure you don't accidentally trigger adverse tax consequences.

5. 401(k)s: You can invest in two types of 401(k)s, and each has its own tax implications. If you invest in a Traditional 401(k), you are taxed at your current tax rate when you withdraw the money. If you invest your funds in a Roth 401(k), the money is taxed when you put the money into the account and is not taxed again when you withdraw  Your financial advisor can advise which option is best for you depending on your current and projected personal and financial situation. 

Why Should Your Financial Advisor Review Your Tax Return?

Your financial advisor should review your tax return annually to better understand your financial situation so they can offer individualized investment advice based on your situation. For instance, an advisor may discover that you have tax-loss carryovers that would allow you to rebalance your portfolio or make additional trades to avoid capital gains taxes.

Your advisor might also realize when looking at your income tax return that you are in a different tax bracket than they assumed, which may cause them to recommend different investments for your portfolio.

If you’re over 72 and are looking for a way to reduce your tax bill, your advisor might recommend charitable deductions you hadn’t thought of. For instance, they may suggest that you gift money to a charity from a Traditional IRA or 401(k). While you won’t benefit from a tax deduction, the donation will reduce your taxable income on a dollar-for-dollar basis.

Finally, your financial advisor may help you find missed deductions on your income tax return. They may suggest that you take a home office deduction if you are self-employed, or they may discover that your health expenses exceeded 7.5% of your adjusted gross income and you are due a deduction for it.

Ask Your Financial Advisor to Plan for Capital Gains Taxes

Planning for capital gains taxes is an important role for a financial advisor, and if they do it right, they can save you money on your taxes. But it’s important to hire an advisor who understands your position and is well suited to work on your portfolio. One good way to find an advisor well suited for your individual needs is to use Datalign Advisory, a platform that connects consumers with financial advisors based on their unique circumstances and needs.

When planning for capital gains taxes, your advisor should monitor your portfolio throughout the year rather than waiting for an end-of-year assessment. That way, they can plan for capital gains and look for ways to offset them. For example, if you incur capital gains on a short-term investment, your financial advisor will likely be able to offset the gains by selling a position at a loss on another short-term investment. As another example, if you have tax loss carryforwards on your tax return, your financial advisor may recommend waiting to sell investments until the capital gains realized and recognized will offset those prior years' tax losses.

Frequently Asked Questions


Is money paid to a financial advisor tax deductible?


Fees paid to a financial advisor are not tax-deductible since the passing of the Tax Cuts and Jobs Act of 2017. But those who operate trusts can deduct a financial advisor’s fees if they can prove that the advice offered was beyond what an advisor would normally give to an individual.


What is the advantage of using a professional advisor?


A professional advisor helps you see the big picture in your finances, plan for retirement and avoid paying unnecessary taxes. A good financial advisor will also help you put up emotional guardrails to ensure that your investments are data-driven rather than based on emotions. An individual working with an investment advisor will, on average, see an additional 3% gain on investment over someone who manages their own portfolio

About Suzanne Kearns

Suzanne is an expert in the insurance, personal finance, real estate and retirement planning space.