Roth IRAs offer a unique advantage: tax-free growth and withdrawals. This tax benefit makes Roth IRAs ideal for holding high-growth investments. But how do you strategically maximize the potential of your Roth IRA? Let’s explore.

The Key Factors to Consider for Tax-Efficient Investing

1. Tax Cost Ratio: A Measure of Tax Efficiency

This metric shows how much a fund’s annualized return is reduced by the taxes investors pay on distributions. The higher the percentage, the less tax-efficient the investment is.

2. Potential Capital Gain Exposure: Predicting Future Taxes

This estimate measures the percentage of a fund’s assets that represent gains. It indicates how much the fund’s assets have appreciated and can signal potential future capital gain distributions.

3. Expected Returns: Leveraging Tax-Deferred Growth

This represents the anticipated return based on historical rates. Investments with higher expected returns may benefit more from the tax-deferred growth offered by accounts like Roth IRAs.

Generally, investments with higher tax cost ratios, higher potential capital gain exposure, and higher expected returns are best suited for tax-deferred accounts like Roth IRAs.

Source: Morningstar

The Withdrawal Dilemma and why prioritizing is important:

Consider a scenario where you need to withdraw $100,000 from a portfolio with a 40% Fixed Income/60% Equity allocation. To maintain this balance, the withdrawal should come from the equity portion. You have two options:

Withdraw $100,000 from a taxable account, paying capital gains tax.

Reposition some Roth IRA funds from equity to fixed income, allowing for a $100,000 withdrawal from fixed investments, reducing capital gains tax.

In almost all cases, Option #1 is preferable. This approach minimizes the disruption to your tax-advantaged growth potential. Exceptions may arise if the investment time frame is very short or the equity growth rate is exceptionally low.

Why Long-Term Growth Belongs in Your Roth IRA

Keeping growth-oriented investments in your Roth IRA maximizes its tax-free growth potential. This strategy is particularly valuable for individuals with a long investment horizon, as the compounding effect can significantly amplify your portfolio’s value over time. By prioritizing growth assets in your Roth IRA, you create a tax-efficient foundation for future wealth.

At Evensky & Katz/Foldes, we understand that tax-efficient investing is a cornerstone of successful portfolio management. By carefully considering asset allocation and withdrawal strategies, we help our clients make the most of their Roth IRAs and other investment accounts.

Ready to take your retirement planning to the next level? Connect with us and start maximizing your financial future.