WSJ Your Money Briefing - How to Avoid Taxes Like the Rich and Famous

Episode Date: December 12, 2024

According to the Tax Policy Center, the highest-income households often pay less tax than middle-class ones, thanks to tax-optimization strategies that have largely been held for the rich. Now, technology is increasing access to those products for individual investors. WSJ Heard on the Street columnist Jon Sindreu joins host J.R. Whalen to discuss what it means for your portfolio.  Sign up for the WSJ's free Markets A.M. newsletter.  Learn more about your ad choices. Visit megaphone.fm/adchoices

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This is not a recommendation or offer to buy, sell, or retain any specific investment or service. Here's your money briefing for Thursday, December 12th. I'm JR Whalen for The Wall Street Journal. Individual investors have gained access to many things that were once only available to the heavy hitters on Wall Street, like options trading. The playing field is being leveled even more with tax optimizing products. What you broadly can get here is automated tax harvesting. You can get, in some cases, direct indexing. You can also get just some simple automated tax management of where you're putting each of your assets, which actually makes a big difference.

We'll talk to Wall Street Journal, Hurt on the Street reporter John Sindaro after the break. Investing in Sports, a four-part series from exchanges, the Goldman Sachs podcast, informed perspectives on the ever-evolving business of sports and the expanding investment ecosystem with leaders at the forefront of the industry. For the sharpest analysis on franchise ownership, media rights, the growing women's sports market, and more, investing in sports from Goldman Sachs Exchanges. Listen now. Wealthier investors often find opportunities to pay less taxes than those in the middle class. Now, people with stock portfolios or 401k accounts can do the same.

Wall Street Journal heard on the street reporter John Sintra joins me. John, why is this typically the time of year when investors at all levels seek out ways to reduce their income tax bill? So we see a little bit of weirdness going on in financial markets usually near the end of the year. Not everything has to do with tax. It also has to do with the risk budgets of asset managers and other issues. But you do see, for example, the famous Santa Claus rally, which is the observation that stocks tend to rally near the end of the year.

Usually one of the theories that holds more water is that it's the reversal of people selling their losing stocks earlier to try and do what is known as tax loss harvesting, where you can offset some of the gainers with some losers. So they do this earlier. And then as we get near the end of the year, there's other people who try and buy them because they think they're cheap. How effective is that, the tax loss harvesting? It is relatively effective. You can have set quite a lot of your gains. So this traditionally has been a tactic that many wealthy individuals have followed, especially since the 1990s. There's a company called Parametric,

which pioneered a strategy that's usually referred to as direct indexing, which means that say, instead of owning an S&P 500 tracker in the form of a mutual fund or whatever it is, you'll just own those stocks individually. And then the advantage of that is, of course, you can dispose of the ones that have been losing money to try and offset your taxes. This is a strategy that is beneficial, particularly for people with like millions of dollars in

wealth, but has issues. And one of them is, well, eventually you run out of losers, right? Because the market tends to go up. You end up with what's being called a frozen portfolio. And here's where all the more complicated strategies have been developed to try to help the wealthy, not so much offset the taxes they have to pay, but more defer the taxes they have to pay. Because if you can defer this for 30 years, you're compounding gains right now, right? And you also pay a smaller long-term capital gains tax than you do a short-term capital

gains tax. What types of investment opportunities do people in the middle class have that would allow them to avoid or defer paying taxes? The interesting thing here is, of course, you can always tax loss harvest and try and sell your losers and all that kind of stuff. The main way that this has gotten easier is just exchange traded funds. ETFs, they are tax advantaged by their very nature. For example, if you own a mutual fund and your fund manager returns you some cash because there's been capital gains or you've earned dividends, whatever it is, even if you were to reinvest that money immediately, you still owe

the IRS. But an ETF is a different structure because the way that it works is that there is a bank that is continuously making what's called transfers in kind. So it's exchanging the basket of stocks that ETF owns for the shares of the ETF. It's like a dealer system. So basically what happens there is that you don't pay tax for any of that. So the ETF is itself already a tax optimized product. On top of this, one of the rules you have to follow if you try to sell one of your losers is that you can't immediately buy a similar security with an ETF because there's so much variety and all of these products are properly diversified.

It makes it far easier to dump something that's lost money and just buy some pretty good ETF. Why have we seen this trend of efforts to try to level the playing field between more sophisticated investors and individuals. It's just the nature of financial markets, especially as technology gets cheaper, access to digital platforms gets cheaper. All of this means now increasingly a computer can do it. And even simple things can help a lot of people. So for example, these mass market wealth platforms, they will automatically tell you this is what the tax on your platforms, they will automatically tell you, this is what the tax on your portfolio is.

They will tell you, hey, you should move these dividend stocks to your tax shelter account. Don't hold it in a taxable account. This kind of stuff, right? It's just very easy to do these days. What kinds of tax optimization options do platforms offer that are geared toward retail investors and people with stock portfolios or 401k accounts? You see a range of options in the market.

If you have an account with a robo advisor, what you broadly can get here is automated tax harvesting. You can get, in some cases, direct indexing, not in every case. You can also get just some simple automated tax management of where you're putting each of your assets, which actually makes a big difference. And we sometimes can't keep track, right? So for example, if you have a 401k or any type of tax sheltered account, it's okay to have dividend paying stocks there. It's okay to have bonds that pay interest there because it's tax sheltered.

If you put it in a taxable account, then you're paying tax on all that stuff. So it makes a lot of sense to keep that in your 401k. And if you have more money and you have a taxable account, then you can keep maybe ETFs that deliver capital gains in there. So it's just a simple way to optimize your final tax bill. But for a lot of people,

this makes a big difference. That's WSJ's John Sindro. And that's it for your Money Briefing. This episode was produced by Ariana Osporou with supervising producer Melanie Roy. I'm JR Whelan for The Wall Street Journal. Thanks for listening. Amazon Q Business is the new generative AI assistant from AWS because many tasks can make business slow, as if wading through mud. Help. Luckily, there's a faster, easier, less messy choice. Amazon Q can securely understand your business data

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