Investors may know that exchange traded funds (ETFs) can be a low cost and transparent investing option, but many overlook another key benefit: tax-efficiency. iShares ETFs can help simplify investing and may allow investors keep more of what they earn.
The following 3 potential benefits may help you get handle on that year end tax bill.
Offset taxes
Through tax loss harvesting
Seek to minimize tax obligations
By maximizing tax sheltered accounts
Insulate yourself from the actions of others
With tax-efficient ETFs
Tax loss harvesting is the act of selling an investment below its purchase price to realize a loss in a taxable account.
While current market volatility may get your portfolio down, consider tax loss harvesting to aim to unlock potential tax benefits.
Armando Senra, Head of Americas ETF and Index Business at BlackRock, and Daniel Prince, CFA, U.S. Head of iShares Product Consulting, discuss ways to potentially reposition your portfolio to help take advantage of tax loss harvesting opportunities while also staying invested.
Armando Senra:
Okay.
Danny Prince:
Okay, Armando. Let's talk tax.
Armando Senra:
Right, so, Danny. We are in 2022. Obviously very difficult market environment, but we are saying that volatility also brings opportunity. Why don't you tell us a little bit more about it?
Danny Prince:
Yeah, Armando, look, it's tough to control markets, but this is an environment where investors may want to consider controlling taxes. And by that, I mean taking advantage of tax loss harvesting opportunities, which is essentially banking a loss today to offset current or future taxes. And really, this is relevant to most investors today, all the way from the most conservative, to the most aggressive.
Armando Senra:
Got it. So you are in this environment where 70 percent of stocks in the market are down for the year. You also have an environment where bonds have the biggest drawdown since the 1980s. So this is the perfect opportunity for investors to do this, right?
Danny Prince:
That's right. This opportunity is critical in this moment. And when you think about the opportunity, Armando, single stocks, single bonds, I think about mutual funds, ETFs. The key here is that investors may want to consider staying invested while taking these losses and navigating the wash-sale rule, so that you can effectively create value in a market that's hard to find. And what we're really telling investors, harvest the losses, stay invested, and this is the opportunity to either rethink or redesign your portfolio going forward.
Armando Senra:
Right, Danny. So what we are saying is, one of the things that investors can consider is, you take your individual stock where you had a loss, you harvest that loss, and you buy an ETF that gives you a diversified exposure. For instance, in the same sector of the market. And you can do the same thing with fixed income ETFs and losses that you want to capture from bonds. So the other benefit is through iShares ETFs, investors stay invested in this very difficult market environment.
Danny Prince:
Yeah, that's right. Armando, the opportunity is abound out there. And really, there's a lot for investors to think about. One thing that I'm thinking about, have you had your second cup of coffee yet?
Armando Senra:
Danny, this is the second cup already.
Danny Prince:
Always one cup ahead of the game. (laughs)
Voice:
Visit ishares.com to view a prospectus, which includes investment
objectives, risks, fees, expenses and other information that you should read and consider carefully before investing. Investing involves risk, including possible loss of principle.
When investing for retirement, it’s critical to stay focused on what really matters — after-tax returns. In other words, don’t let taxes take a backseat to other key considerations such as costs and risk.
Taxes can be a big drag on your long-term returns: in 2021, the tax costs of the average active U.S. equity mutual fund were more than double the expense ratio.2 Even a seemingly small tax rate of 2% would cost a hypothetical $100,000 portfolio over $45,000 after a decade of 10% average annual returns.3
A potential way to generate after-tax returns is to maximize your savings in tax-advantaged accounts. Remember, it’s not what you make, it’s what you keep, so talk to your financial advisor about (re)positioning your portfolio for after-tax returns.
A 401(k) plan is an investment account offered by employers that allows you to save for retirement. If your company offers a 401(k) plan, it will have certain eligibility requirements. Eligibility requirements vary by firm, as does whether and how a company contributes to its employees’ 401(k) plans.
There are two common types of 401(k) plans: Traditional and Roth. Both types of 401(k) plans are subject to the same annual contribution limit, which is $20,500 for 2022 and $22,500 for 2023. If the plan administrator allows, participants aged 50 or older can also make additional catch-up contributions of up to $6,500 for 2022 and $7,500 for 2023. (Other types of 401(k) plans include the SIMPLE 401(k) plan, which is designed for small businesses with 100 or fewer employees who receive at least $5,000 in annual compensation.)
Contributions to traditional 401(k) plans are typically made before taxes, while withdrawals are subject to income tax. This structure helps individuals lower the amount of income subject to taxes in the present and then withdraw funds.
When it’s time to start using your traditional 401(k) plan savings, be sure to consider the tax implications. With a 401(k), you can typically start to take penalty-free withdrawals when you turn 59 ½. But if you need the funds before then, you could incur an additional 10% early withdrawal tax penalty — on top of what you’d normally pay in state and federal taxes — unless an exception applies.
Roth 401(k) plans work differently from traditional plans: Contributions are made after taxes, while withdrawals are tax free. Because you’ve already paid taxes on you’re savings, withdrawals won’t be taxed as long as you meet both of the following criteria:
Another big difference between traditional and Roth 401(k) plans centers around whether the IRS mandates withdrawals from the plan. Most Americans are required to start taking distributions from traditional 401(k) after they reach age 72, while there are no age-related withdrawal requirements for Roth 401(k) plans.
An Individual Retirement Account, commonly known as an IRA, is designed to help individuals save for retirement. As with 401(k) plans, there are two common types of IRAs: Traditional and Roth. (Another type of IRA is a Simplified Employee Pension plan, or SEP, where an employer makes direct contributions for each employee.)
A traditional IRA is a retirement account in which individuals can make pre-tax contributions.
You can start to withdraw your savings penalty-free when you reach age 59 ½. Taking out your savings before that time could cost you an extra 10% on top of what you’d normally pay in state and federal taxes.
Once you turn 72, you typically have to withdraw a minimum amount annually to comply with distribution requirements. The exception is Roth IRAs, which never force you to take withdrawals.
403(b) plan: Similar to a 401(k) plan in its structure and function. While 401(k) plans are used by employees of for-profit companies, the 403(b) is designed for employees of non-profits and government organizations such as public schools.5
529 plan: Designed to help Americans save for and pay the cost of higher education. Withdrawals from 529 plans are tax free provided the funds are used for so-called “qualified” education expenses, including tuition, books, and room and board at accredited institutions. Contributions into 529 plans are made on an after-tax basis; the maximum annual contribution to an individual 529 plan is $80,000, or $160,000 for a married couple. These limits are based on contributions prior to triggering a gift tax.
Health Savings Account (HSA): Allows individuals to set aside pre-tax dollars to use for health-related expenses. HSAs are only available to people with a high deductible health plan, with a minimum deductible of $1400 for individuals and $2800 for families in 2022. Those who qualify for HSAs in 2022 can contribute up to $3650 for an individual or $7300 for a family. A portion of the HSA can be invested in a variety of financial instruments and the gains from interest or price appreciation are not taxable.6
Flexible Spending Account (FSA): An employee-sponsored plan similar to an HSA. An FSA allows people to use pre-tax dollars — up to $2750 per year — to pay for health-related expenses. A major difference is that FSAs have an annual “use it or lose it” feature: A maximum of $500 in FSAs can be carried over from one plan year to another, while there’s no rollover limit on HSA funds.7
Exchange-traded funds (ETFs) are generally designed to be tax efficient, helping investors keep more of what they earn. ETFs held 24% of U.S. managed fund assets in 2021 yet were responsible for less-than 1% of capital gains distributions.8
Most ETFs are index funds, which generally trade less than their actively managed counterparts. This “low turnover” means index ETFs typically have to sell holdings that have appreciated in value less often, which helps to avoid triggering realized capital gains.
ETFs trade on exchanges, just like stocks. As a result, ETF managers don’t have to sell holdings. With an ETF, you control if and when you sell and are never taxed as a result of actions by other shareholders.
Taxes can make a significant impact on return and, in many cases, can be just as important as other factors in your investment decision. For example, on a $100,000 investment over a 10 year period, the impact of taxes could be in the tens of thousands.
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iShares unlocks opportunity across markets to meet the evolving needs of investors. With more than twenty years of experience, iShares continues to drive progress for the financial industry. iShares funds are powered by the expert portfolio and risk management of BlackRock.
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1 Source: BlackRock. The chart is for illustrative purposes only and is not indicative of the performance of any actual fund or investment portfolio. Does not include commissions or sales charges or fees. 15% represents the average pre-tax return over the same 10 year period for large cap equity mutual funds (14.86%). The hypothetical growth of $100,000 over ten years at an 15% return is $404,556. The hypothetical growth over ten years at an 15% return with a 2.09% tax cost is $336,762, resulting in a tax cost of $67,693.
2 Morningstar. As of Dec. 31, 2021.
3 Tax Cost measures how much a fund's annualized return is reduced by the taxes investors pay on distributions (Difference between total annualized pre and post-tax returns over 10 years.) Data calculated using the oldest share class of all Active US large cap Equity Open-End Mutual Funds available in the U.S.
4 Source: IRS.gov, BlackRock.
5 Source: IRS.gov.
6 Source: Healthcare.gov.
7 Source: Healthcare.gov, IRS.gov.
8 Source: Morningstar, as of 12/31/21. ETFs only pay 0.42% of capital gains distributions.
For more information on the differences between ETFs and mutual funds, click here.
Carefully consider the Funds' investment objectives, risk factors, and charges and expenses before investing. This and other information can be found in the Funds' prospectuses or, if available, the summary prospectuses, which may be obtained by visiting the iShares Fund and BlackRock Fund prospectus pages. Read the prospectus carefully before investing.
Investing involves risk, including possible loss of principal.
The strategies discussed are strictly for illustrative and educational purposes and are not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. There is no guarantee that any strategies discussed will be effective.
Transactions in shares of ETFs may result in brokerage commissions and will generate tax consequences. All regulated investment companies are obliged to distribute portfolio gains to shareholders.
Shares of ETFs may be bought and sold throughout the day on the exchange through any brokerage account. Shares are not individually redeemable from an ETF, however, shares may be redeemed directly from an ETF by Authorized Participants, in very large creation/redemption units.
Certain traditional mutual funds can also be tax efficient.
Investment comparisons are for illustrative purposes only. To better understand the similarities and differences between investments, including investment objectives, risks, fees and expenses, it is important to read the products' prospectuses.
The information provided is not intended to be tax advice. Investors should be urged to consult their tax professionals or financial professionals for more information regarding their specific tax situations.
The Funds are distributed by BlackRock Investments, LLC (together with its affiliates, "BlackRock").
©2023 BlackRock, Inc or its affiliates. All Rights Reserved. BLACKROCK, iSHARES, iBONDS, LIFEPATH, ALADDIN and the iShares Core Graphic are trademarks of BlackRock, Inc. or its affiliates. All other trademarks are those of their respective owners.
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