Investing outside of retirement accounts can feel like an exciting opportunity to grow your wealth while remaining flexible. You’re not restricted by contribution limits or rules about when you can access your money. However, beyond the freedom lies the challenge of managing your tax bill. Taxes, if not carefully considered, can quietly eat into your returns, making it harder to grow your wealth over time. 

Here’s a guide to mastering tax-efficient strategies outside of your retirement accounts, with simple, actionable steps to make your money work harder for you.

The Hidden Costs of Non-Retirement Accounts 

Investing outside of retirement accounts might sound straightforward, put money in, earn returns, and grow your wealth. But here’s the catch: taxes. 

Every time you earn interest, dividends, or sell an investment for a profit, Uncle Sam comes knocking. This “tax drag” can slowly chip away at your returns year after year, especially when combined with the effects of inflation. 

Nerd Note: Did you know that over 30 years, a portfolio facing just a 1% annual tax drag could lose nearly a third of its potential value? That’s the silent power of compounded losses.

Why Tax-Efficiency Matters for Your Wealth

Without tax-smart strategies, your portfolio may not reach its full potential. Here's a closer look at why understanding taxes on your investments is so important.
Understanding Taxes on Investments

Not all investment gains and earnings are taxed equally. Here’s the quick breakdown:

• Ordinary Income Tax: This applies to interest income (e.g., from savings accounts, bonds, or CDs) and non-qualified dividends. These can be taxed as high as your regular income tax rate.
• Long-Term Capital Gains Tax: Hold investments for over a year before selling, and gains may be taxed at a lower rate (0%, 15%, or 20%, depending on your income).
• Dividend Tax Rates: Qualified dividends, like those from many U.S. stocks, are taxed at capital gains rates, while non-qualified dividends are hit with higher ordinary income tax rates.

The Impact of Inflation on Returns 

Now, mix inflation into the equation. Even if your investments grow by 7% annually, a 3% inflation rate cuts that down to 4% in real terms. Add taxes, and your actual returns could become razor-thin, making it critical to keep your tax strategy strong.

Key Benefits of Tax-Savvy Investing

• Higher Net Returns: By reducing taxes, more of your returns stay in your pocket.
• Compounding Growth: When taxes are deferred or minimized, your earnings can grow exponentially over time.

Top Strategies for Tax-Efficient Non-Retirement Investing

1. Focus on Asset Location 

Think of asset location as deciding what goes where. Place tax-inefficient investments (like REITs or bonds) in pre-tax or tax-advantaged accounts, while putting tax-efficient assets (like municipal bonds or index funds) in taxable accounts. 

For example, municipal bonds are great for taxable accounts due to their federal (and often state) tax-exempt status. 

2. Maximize Long-Term Capital Gains 

Holding assets for more than a year reduces your tax rate on any gains. It’s simple, but effective. Avoid frequent trading, and be mindful of the temptation to chase short-term profits. 

3. Explore Tax-Loss Harvesting 

Sometimes, losing isn’t so bad. Tax-loss harvesting is a strategy where you sell investments that have lost value to offset gains from other investments or up to $3,000 of ordinary income annually. This lowers your overall tax bill. 

Nerd Note: Harvested tax losses can be carried forward indefinitely, allowing you to offset future gains for decades. However, watch out for the “wash-sale rule,” which prevents you from repurchasing the same investment within 30 days. 

4. Leverage Municipal Bonds for Tax-Free Income 

High earners often benefit from municipal bonds, which provide tax-free income at the federal level (and sometimes at the state level too, if you live in the bond’s state). Though yields may be slightly lower compared to taxable bonds, the tax savings can make up for it.

5. Invest in Tax-Efficient Funds 

Not all funds are created equal when it comes to taxes. Low-turnover ETFs and index funds are some of the best options for taxable accounts because they trigger fewer taxable events compared to actively managed funds. 

6. Consider Donor-Advised Funds (DAFs) 

For those who are charitably inclined, donor-advised funds provide a win-win opportunity. By donating appreciated assets, you can avoid capital gains taxes while claiming a full deduction on the asset’s current value. The best part? You have the flexibility to support your chosen causes on your timeline. 

7. Direct Indexing- Personalized Exchange Traded Fund

While individual stock traded accounts remind me of the old stock broker days, pushing any news onto client investors, direct indexing can be the same underlying exposure in the markets but in a different vehicle. Rather than driving a tractor trailer equivalent of an investment over the years. driving thousands of individual cars, will allow greater flexibility to harvest individual losses as some investments decline and reinvest elsewhere. Studies show that this strategy alone may increase after tax returns from 0.5-1.5% annually.

Nerd Note: Direct Indexing is a fantastic way to harvest massive tax losses leading into a business or large asset sale to save tens of thousands in tax.

Three Common Pitfalls to Avoid

1. Ignoring the Role of Dividends 

Not all dividends are equal. Qualified dividends are taxed at lower capital gains rates, while non-qualified dividends face higher ordinary income tax rates. Prioritize investments that distribute qualified dividends in taxable accounts. 

2. Overlooking Step-Up in Basis Rules 

When assets are passed to heirs, their cost basis is “stepped up” to the asset’s value on the date of your death. Though, this doesn't happen automatically so it is important to review this if inheriting any funds. This essentially erases any unrealized gains for your heirs. Holding certain high-gain investments until death can reduce their tax burden significantly. 

3. Not planning ahead for liquidity events

Planning ahead for a major sale is imperative to having enough time to offset the taxes associated with it. I have worked with countless business owners and professionals utilize a combination of these strategies over a multi year period to largely or entirely offset their business sale tax gains.

4. Having Large Mutual Fund holdings

Each year, mutual funds pass onto shareholders the underlying tax sales within the fund, most of the time the largest "captial gain distributions" occur at the end of the year and therefore hard to plan for. Some are "short term" taxed at your ordinary higher tax rates where some are "long term", regardless, if you have a sizeable portion of your portfolio in this type of holding, you should look carefully on what the fees and taxes are costing you. See our article for more information on how this tax experience differs between ETFs and Mutual funds.

How to Future-Proof Your Investment Portfolio

Tax laws change, and so does life. A well-maintained portfolio is one that adapts to these changes. Review your portfolio annually to ensure it aligns with your goals and evaluates tax efficiency. 

Nerd Note: Instead of selling investments to rebalance your portfolio (which could trigger taxes), consider using new contributions to rebalance instead. It’s a smart, tax-efficient approach.

Smart Wealth Building for a Stronger Tomorrow 

Smart investing isn’t just about chasing returns, it’s about ensuring that the dollars you earn work their hardest for you. By prioritizing tax efficiency in your non-retirement investments, you secure more of those dollars for your future, allowing you to grow wealth at a greater pace. 

At HealthyFP, we’re passionate about helping you make smarter financial decisions that stand the test of time. Take the first step toward building a stronger, tax-efficient portfolio and watch your wealth grow.