Key Takeaways
Implementing an active tax-management strategy for your Investing?
Even investors who dedicate significant effort to optimizing portfolio performance often lack a formal strategy for minimizing the taxes on those returns.
Utilizing an active tax-management approach for your investments may help decrease your overall tax burden. Even modest reductions in tax payments today can lead to a substantial increase in your long-term wealth.
Some investors only consider tax implications during the spring filing season, but there are opportunities to save throughout the entire year. Consider implementing some or all of the following potential strategies.
Use Tax-Aware Asset Location
Different account types are governed by varying tax regulations. A tax-aware asset location strategy that considers these distinctions may improve your after-tax returns. For instance, by placing income-generating taxable assets—such as corporate fixed income and dividend-paying stocks—into tax-deferred or tax-exempt accounts like Individual Retirement Accounts, you can help reduce your exposure to immediate taxes. Conversely, consider holding nontaxable assets, such as municipal bonds, within your taxable accounts. Your financial advisor can work with your tax professional to structure an asset location strategy tailored to your various accounts.
Consider Tax-Favorable Investment Solutions
Many investment options allow you to pursue financial goals while providing tax advantages. Municipal bonds, which are generally exempt from federal taxes and often state and local taxes as well, can serve as a tax-efficient hedge against current or rising tax rates. Beyond municipal bonds, you might consider tax-efficient mutual funds or separately managed accounts designed to minimize taxable events within your portfolio.
If you are saving for future education costs, a 529 savings plan offers a tax-advantaged way to accumulate funds for qualified expenses, such as college tuition.
For those saving for retirement, diversifying your portfolio with a variable annuity may offer potential for tax-deferred growth, guaranteed lifetime income, increased retirement savings, equity upside potential, and a death benefit for your beneficiaries.
Finally, if you are charitably inclined, consider utilizing a donor-advised fund (DAF). When you contribute to a DAF, you may qualify for a federal income tax deduction if you itemize, while retaining the ability to recommend which charities receive the funds now or in future years. These assets can also grow through investments over time.
Employ Tax-Loss Harvesting
Current U.S. federal tax law allows for tax-loss harvesting, a method of offsetting capital gains with capital losses incurred during the same tax year or carried over from a previous one, which may reduce your total federal tax liability. This strategy can be particularly beneficial during periods of significant market volatility.
Capital gains are generally the profits realized when you sell an asset—such as stocks, art, or personal real estate—for more than its purchase price, while capital losses occur when you sell an investment for less than you paid for it.
If your capital losses exceed your capital gains, you can use the excess to offset up to $3,000 of ordinary income each year. Any remaining excess losses can be carried forward to offset taxes in future years.
While you may want to reinvest the proceeds from harvested losses, ensure you do not inadvertently trigger a “wash sale.” This occurs when you sell or trade securities at a loss and then purchase substantially identical securities within 30 days before or after the sale date. Discuss your options with your financial advisor.
Max Out Retirement Plans
Consider maximizing contributions to your employer-sponsored retirement benefits, such as a 401(k), as these contributions are typically made on a pretax basis. Contributing to a traditional IRA can also reduce your taxable income for the year, as these contributions may be tax-deductible. Because these are tax-deferred accounts, you generally do not pay income taxes on contributions or investment earnings until you withdraw the funds.
For the 2025 tax year, you can contribute up to $23,500 to your 401(k). If you are age 50 or older, you may be eligible for an additional catch-up contribution of up to $7,500 (or $11,250 for those aged 60 to 63), provided the plan allows it.
Engage in Legacy Planning and Gifting
For 2025, the federal estate tax exemption has risen to $13.99 million per individual and $27.98 million for married couples. Regardless of whether you expect to owe estate taxes, all investors should maintain an estate plan that aligns with their wealth-transfer objectives.
Trusts can be an effective mechanism for reducing estate taxes or ensuring the equitable distribution of wealth among family members. Taxpayers with taxable or potentially taxable estates who wish to provide for their family should consider making lifetime gifts. This is a tax-efficient strategy because it removes any future appreciation of the gifted asset from your taxable estate.
Additionally, consider making annual exclusion gifts before the end of the year. For 2025, these gifts can be up to $19,000 per recipient for individuals and $38,000 for married couples who elect to split gifts. Keep in mind that tuition payments made directly to an educational institution and medical expenses paid directly to a provider are not considered taxable gifts and do not count against your annual exclusion or reduce your federal lifetime gift tax exemption.
Help Minimize Your Overall Tax Bill
Through Total Tax 365, Morgan Stanley Financial Advisors provide tax-smart techniques and strategies to help you mitigate the impact of taxes throughout the year. Speak with your Morgan Stanley Financial Advisor to learn more.
Furthermore, if you have complex tax planning requirements, your Morgan Stanley Financial Advisor can connect you with experienced tax professionals at leading U.S.-based firms to help ensure your strategy is fully optimized.
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Your Guide to Tax-Efficient Planning
Footnotes
1 Contributions to traditional IRAs may be tax-deductible depending on whether you or your spouse is covered by a qualified retirement plan at work, your modified adjusted gross income and federal tax filing status. Consult with your financial advisor/tax advisor to see which account is right for you.
