Pocket more of your return and save on taxes with these tips, says Bank of America

Published Wed, Mar 13 20242:39 PM EDTUpdated Wed, Mar 13 20242:55 PM EDT

It's too late to do much about the taxes you owe for 2023, but you can get ahead of the levies taking bites out of your portfolio in 2024, Bank of America found. Taxpayers have about a month to file their 2023 income taxes and pay sums owed. The big deadline is April 15. With the stock market in the middle of a sharp rally and the S & P 500 up 34% over the past year, investors would be well-served to think of steps they can take today to minimize the tax hit going forward. .SPX 1Y line S & P 500 performance over past year "We see long-term value in simple, tax-aware investing advice," wrote Jared Woodard, an investment and ETF strategist at Bank of America, in a Tuesday report. To that end, he detailed a series of steps investors can take now to make their portfolios more tax efficient. Taking a closer look at your holdings The first step is as simple as looking at whether you can swap out some of your existing mutual funds for exchange-traded funds, a move that can save investors one percentage point annually. That's because exchange-traded funds are generally less likely to spin out hefty year-end capital gains distributions . Managers of mutual funds have to sell their holdings to cash out departing investors, so you may still see a capital gain distribution even in a year when the fund underperforms. An investor who put $100,000 into an S & P 500 ETF in October 2013 and held onto it would've wound up with $279,000, compared with $248,000 if the money went into an S & P 500 mutual fund, Bank of America found. Take a measured approach to selling this mutual fund, as dumping it altogether may mean you're taking a tax hit on realized gains if the fund has appreciated considerably. You can wind down the position gradually or consider selling some losing positions to counteract the capital gains you'd incur. This is known as tax-loss harvesting . Where are you holding bonds? The second step investors can take to trim their tax bill is to watch their asset allocation, especially with fixed income. The Treasurys, money market funds and other fixed income assets investors have loved amid higher rates have a surprise side effect: The interest they spin off is taxed as ordinary income, which can hit at a top rate of 37%. "Equities are more tax-efficient because dividends are a lower proportion of total equity returns," wrote Woodard. "Fixed income returns, by contrast, come almost entirely from coupon payments, which can be taxable at the highest rates." You may also want to think about where you're holding these fixed income assets. Since the tax treatment of the interest income is so harsh, it could make better sense to keep them in a tax-deferred account, such as your individual retirement account or 401(k) plan, as opposed to your taxable brokerage account. A third move: Woodard also advised investors to think about high-yield municipal bonds and their ability to generate more tax-advantaged income compared to other fixed income assets. Generally, municipal bonds spin out income that's free of federal tax. If an investor resides in the state where the bond is issued, the income may also be free of state and local taxes. "[High yield] munis offer 8-9% yields on a tax adjusted basis, 450 bps more than the US aggregate bond index," the strategist wrote. "Aggregate bond coupons are taxable at ordinary income rates." Be aware that higher yield generally comes with higher default risk, but generally, municipal bonds aren't as risky as their corporate counterparts. Dividends or buybacks? The fourth step to save on taxes: Consider whether a buyback ETF or a dividend ETF is right for you. Woodard recommends favoring buybacks if investors have the goal of long-term wealth accumulation, citing buybacks' tax efficiency compared to dividends. "Even if dividends are qualified, payouts are taxed at the end of every year where they're received," he said. "Holding companies that execute repurchase programs [does] not typically trigger a tax event until an investor sells their shares." Woodard recently highlighted the iShares Core Dividend ETF (DIVB) and the Invesco BuyBack Achievers ETF (PKW) as buyback plays. DIVB has an expense ratio of 0.05% and a one-year total return of 23.4%, while PKW has a one-year total return of 26% and an expense ratio of 0.62%, per Morningstar. He also noted that true income investors may want to go with dividend funds, including Schwab US Dividend Equity ETF (SCHD) and Vanguard High Dividend Yield ETF (VYM) . SCHD has a total expense ratio of 0.06% and a one-year total return of 13.9%, while VYM also totes an expense ratio of 0.06% and a one-year total return of 18.1%, according to Morningstar. "Dividends are an attractive trade this year and can benefit from lower rates," Woodard wrote. "They can also act as a haven if inflation reaccelerates."