Why our physician clients focus on tax efficiency

  • Keep more of what you earn: Two portfolios with the same pre tax return can leave very different amounts in your pocket after tax. For high earners, the drag from taxes on interest, dividends, and gains can quietly cost a meaningful slice of return every year.
  • High marginal rates make it matter more: Physicians often sit in the top federal bracket (37%), may owe an extra 3.8% surtax on investment income, and pay state income tax on top. The higher your rate, the more each tax-saving move is worth.
  • It compounds: Money not paid in tax this year stays invested and keeps growing. Over a long career, small annual savings can turn into a large difference in ending wealth.
  • You control more than you think: Where you hold an asset, what you hold, and when you sell are all within your control, even when markets are not.

Educational overview only, not financial, investment, tax, or legal advice. Tax rules change and depend on your specific situation. Please confirm any strategy with your tax professional before acting.

1. Put the right assets in the right accounts (asset location)

  • The core idea: You likely hold money across three buckets, taxable brokerage accounts, tax deferred accounts (401(k), traditional IRA), and tax free accounts (Roth IRA, Roth 401(k), HSA). Placing each type of investment in the account where it is taxed most lightly is called asset location.
  • Tax-inefficient assets go in sheltered accounts: Holdings that throw off income taxed at ordinary rates, such as taxable bonds, REITs, and actively traded funds, generally belong in tax-deferred or Roth accounts where that income is not taxed each year.
  • Tax-efficient assets can sit in taxable accounts: Broad stock index funds and ETFs produce mostly qualified dividends and long term gains, taxed at lower rates, so they are well suited to a taxable brokerage account.
  • Highest-growth assets in Roth: Because Roth growth is never taxed, your highest expected return holdings often have the most to gain from sitting there.
  • Look at the whole picture: Asset location works across all your accounts at once, so your overall investment mix can stay the same while the tax bill shrinks.

2. Favor tax efficient investment vehicles

  • Index funds and ETFs over active funds: Broad index funds trade infrequently, so they pass through few taxable capital gains. Many actively managed funds buy and sell often and distribute gains to you each year, sometimes even in a year the fund lost value.
  • ETFs versus mutual funds: ETFs are generally more tax efficient than comparable mutual funds because of how they handle redemptions, which lets them avoid distributing most capital gains.
  • Watch year-end distributions: Mutual funds often pay out capital gains in December. Buying one right before its distribution date in a taxable account can hand you a tax bill on gains you never enjoyed. Fund companies publish estimated distribution dates each fall; check before buying in November or December.
  • Mind turnover: A fund's turnover ratio is a rough guide to how much taxable activity it generates. Lower turnover usually means a smaller annual tax drag in a taxable account.

3. Use municipal bonds for tax free income

  • What they are: Municipal bonds (munis) are debt issued by states, cities, and other public bodies. The interest is generally exempt from federal income tax, and often from state tax too if you buy bonds issued in your own state.
  • Who they suit: Because the benefit is the tax you avoid, munis tend to favor investors in higher tax brackets. The higher your rate, the more a tax-free yield is worth relative to a taxable one.
  • Compare on an apples-to-apples basis: Use the taxable equivalent yield to weigh a muni against a taxable bond. It equals the muni yield divided by (1 minus your marginal tax rate). For example, a 3.5% muni yield is worth about 5.6% in a taxable bond for someone in the 37% bracket.
  • In-state versus national: In state munis can add state tax savings but concentrate your risk in one state's economy. National muni funds spread risk across many issuers but may give up some of the state-tax benefit.
  • A caution on AMT and Social Security: Some munis (private activity bonds) can trigger the alternative minimum tax, and muni interest can affect how much of your Social Security is taxed later. Both are worth checking before you buy.

4. Know the state tax angle on Treasuries

  • Treasuries are state tax free: Interest from US Treasury bills, notes, and bonds is exempt from state and local income tax, though it remains federally taxable. For clients in high tax states, that makes Treasuries more attractive than the headline yield suggests.
  • The mirror image of munis: Where munis avoid federal tax, Treasuries avoid state tax. Which fits better depends on your federal versus state rates and the yields available at the time.
  • Cash counts too: A government or Treasury money market fund can carry the same state tax exemption on its Treasury portion, which is easy to overlook on large cash balances.

5. Harvest losses to offset gains (tax loss harvesting)

  • The idea: When an investment in a taxable account falls below what you paid, you can sell it to realize a loss and use that loss to offset capital gains elsewhere. Up to $3,000 of net losses can offset ordinary income each year ($1,500 if married filing separately), and any excess carries forward indefinitely.
  • Stay invested: To keep your market exposure, you typically reinvest the proceeds in a similar (but not identical) holding right away, so you are effectively out of the market for no time at all.
  • The wash-sale rule: If you buy the same or a substantially identical security within 30 days before or after the sale, the loss is disallowed. Switching to a different fund that tracks a similar index is the common way to stay clear of it. Cryptocurrency currently sits outside the wash-sale statute (it is property, not a security), but see the caution in our Tax Loss Harvesting guide before relying on that.
  • It defers tax, it does not erase it: Harvesting lowers your new holding's cost basis, so the tax shows up later when you sell. The benefit is the value of paying later, plus the chance to realize gains in a lower rate year.

6. Mind holding periods, gain rates, and the surtax

  • Long term beats short-term: Gains on assets held more than one year are taxed at 0%, 15%, or 20%, well below the ordinary rates (up to 37%) that apply to assets held a year or less. Crossing the one year mark before selling can sharply cut the tax.
  • Qualified dividends get the better rate too: Dividends that meet IRS holding requirements are taxed at the same favorable 0/15/20% rates rather than as ordinary income.
  • The 3.8% surtax: High earners may owe an extra 3.8% Net Investment Income Tax on investment income once modified income passes $200,000 (single) or $250,000 (married filing jointly). These thresholds are not indexed for inflation, so more clients cross them over time.
  • Timing sales: Spreading a large sale across two tax years, or realizing gains in a lower-income year such as a sabbatical or early retirement, can keep more of the gain in the lower brackets.

7. Consider direct indexing for larger taxable accounts

  • What it is: Instead of buying a single index fund, direct indexing holds the individual stocks of an index in your own account. That opens up loss harvesting at the individual stock level, even in years the index as a whole rises.
  • The benefit: More holdings means more chances to harvest losses on the names that fell, generating losses you can use against other gains, including gains from selling a practice or another concentrated position.
  • The tradeoffs: It usually calls for a larger account, carries more complexity and higher fees than a plain index fund, and creates many more tax lots to track. It tends to fit clients with sizable taxable balances and ongoing gains to offset.

8. Coordinate giving and estate moves with your portfolio

  • Give appreciated shares, not cash: Donating long term appreciated stock or fund shares to charity lets you skip the capital gains tax and still deduct the full value, which a donor advised fund can streamline.
  • Step up in basis at death: Assets held until death generally pass to heirs with a stepped up basis, which erases the unrealized gain. In some cases that argues for holding a highly appreciated position rather than selling it.
  • Roth conversions in low income years: Converting traditional retirement money to Roth during a lower income window shifts future growth into the tax free bucket, though it adds taxable income in the year you convert.