Morgan Stanley
  • Wealth Management
  • May 27, 2022

The Tax-Smart Portfolio: Helping to Keep More of What You Earn

Tax strategies can have a surprisingly large potential impact on lifetime wealth accumulation. A look at some of the techniques that could help you keep more money growing.



Every investor is looking for an edge that helps them boost their overall wealth. But one strategy that some investors don’t pay enough attention to is tax efficient investing. The reason? Even small reductions in tax costs can have enormous consequences for wealth accumulation

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In an example drawn from a Morgan Stanley report,1 an improvement of 0.5% per year in after-tax returns resulted in a difference of 50% in final wealth after 30 years of retirement income distributions.2 No small improvement.

“People are often surprised to learn just how much of their long-term investment returns go to taxes, and how much of a difference that can make in terms of whether or not they will meet their financial goals," said Lisa Shalett, Morgan Stanley Wealth Management Chief Investment Officer.

Faced with a shortfall between lifestyle plans and wealth accumulation, some investors consider options like delaying retirement or taking on more investment risk in an attempt to boost returns. But a key strategy for boosting long-term returns—which may not necessarily add risk—is being smart about tax efficiency.

Utilizing a Variety of Strategies

The benefits of tax-deferral vehicles such as 401(k)s and individual retirement accounts (IRAs) are well known, and naturally a tax strategy should start by utilizing those vehicles. For many people, the simple strategy of making pre-tax contributions to a 401(k) account or tax-deductible contributions to an IRA and deferring taxes as long as possible can be effective, because it allows your investment earnings to compound without the headwind of a front-end tax payment.

Another option is to put aside money for specific categories of spending like education and health care using tax-deferred accounts such as 529 plans or Health Savings Accounts (HSAs).

But there are also lesser-known strategies that can also meaningfully add to your long-term wealth. 

Compared to a 401(k), the annual additional returns generated by the lesser-known strategies may seem small. But just as the power of compounded interest can help small early-career contributions balloon over the decades, small losses due to taxes can snowball over a lifetime.

For example, higher income investors who can max out their tax- deferred qualified retirement accounts can add additional strategies, such as investing in tax-exempt municipal bonds. They can also use “tax managed” investment products that hold gains and “harvest” any losses that are incurred during the tax year or carried over from a prior tax return; these tax losses can also be used to offset capital gains for tax purposes. As with qualified retirement accounts, tax managed investment strategies work by deferring tax costs into the future. 

For high net worth investors, insurance and annuities products can also be effective in helping to reduce the impact of taxes on lifetime wealth. These include:

  • Investment-Only Variable Annuities (IOVA). Investors who have hit the contribution or income caps for qualified retirement accounts such as 401(k)s and IRAs can direct post-tax savings to a non-qualified IOVA, where investment gains are not taxed until they’re withdrawn and assets are not subjected to required minimum distributions (RMDs). This relatively new vehicle is designed for wealth accumulation, coming without the more costly features of other variable annuities, such as guaranteed withdrawal benefits, but with a broader menu of investment options. Its impact on wealth generation is greatest for investors with a long time horizon.
  •  Index / Variable Universal Life Insurance. Another avenue for individuals who have maxed out their qualified retirement accounts, these policies combine potential wealth accumulation with protection for family in the event of the investor’s death. Under certain circumstances,3 the policy buyer pays premiums in early years, the majority of which, after fees and the cost of insurance, are invested in the markets or linked to the performance of a stock market index, and the cash balance potentially grows tax-deferred. Subject to certain restrictions, the cash value of an index / variable universal life policy can be accessed tax free, initially through withdrawal of principal and subsequently by loans against its death benefit.

While each of these products can help improve tax efficiency in isolation, their full potential to boost after-tax returns can only be unlocked when they are set up as building blocks in a more complex, integrated tax strategy. 

For example, when you have a mix of accounts and products with different tax treatments you can increase the impact of the tax advantaged accounts through “tax-efficient asset location,” which locates the investments contained within an overall strategy into different account types according to their growth potential and relative tax efficiency. 

A retirement income plan is another way in which the different components of a tax strategy can complement one another, by sequencing the order of asset sales in a tax efficient way. A simple withdrawal sequence might involve withdrawing from taxable accounts first and tax-advantaged accounts last, but, according to Daniel Hunt, Morgan Stanley Wealth Management Senior Investment Strategist, even-more complex withdrawal sequencing strategies can have a significantly greater impact on lifetime spending power. For example, distributing savings that don’t register as taxable income, like certain municipal bond coupon payments, or taking loans4 from an index / variable universal life insurance policy, while converting portions of tax-deferred savings into a Roth IRA can “smooth” your reported income, so you pay lower average rates, while continuing to shelter your investments from tax.

"Overall, how these different approaches are combined can make a significant difference when it comes to building wealth over the long term. Each of them can be helpful in and of themselves, but in concert they can provide much more significant compounded benefits that can really move the needle. If you have a Financial Advisor who’s willing to sit with you and your tax advisor and put together a comprehensive strategy where the pieces work together, that can make all the difference," Hunt said.

As part of Morgan Stanley’s Total Tax 365, your Financial Advisor or Private Wealth Advisor has access to some of the tax-management solutions.

In addition, if you have complex tax planning needs, your Financial Advisor can connect you to experienced tax planning professionals at leading U.S.-based providers across the country to help you optimize your tax strategy.

If you haven’t taken a look at how tax-efficient investing can help lower your tax burden and increase long-term wealth, talk with your Financial Advisor or Private Wealth Advisor and ask for a copy of the whitepaper, Tax Efficiency: Getting to What You Need by Keeping More of What You Earn

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