• Traditional 401(k)s and IRAs are funded with “pre-tax” dollars—meaning contributions aren’t subject to current taxes—and can potentially grow tax-deferred. However, withdrawals are taxed as ordinary income. Also, once you turn 73, you have to withdraw a certain amount each year, known as a required minimum distribution (RMD), which may bump you into a higher-than-desired tax bracket.
• Roth accounts, on the other hand, are funded with “after-tax” dollars, but assets may grow tax-free and can be withdrawn tax-free, and there are no RMDs.

  If you aren’t already doing so, take full advantage of the benefits of tax-advantaged accounts like 401(k) and individual retirement accounts (IRAs), including contributing the maximum allowable amount each year, ideally with matching funds from an employer. 

  It’s also important to weigh the tradeoffs of different account types: 

What choice is right for you? If you expect your income needs will be lower in retirement than during your working years, as is the case for many retirees, traditional accounts might make more sense. However, if tax rates increase in the future, Roth accounts and their tax-free withdrawals may become more attractive. You can also consider a hybrid approach, for example, using the option some employers provide to convert after-tax 401(k) contributions to a Roth 401(k) in the year they are contributed. For some people, a hybrid approach can capture the best of both worlds.

If you’ve maxed out tax-advantaged retirement accounts or cannot use them due to restrictions or income limitations, there are other tax-efficient strategies to consider when investing in stocks, depending on how you prefer them to be managed:

Investors who prefer passively investing in equity indices like the S&P 500 may want to consider direct indexing. Here’s how it works: Instead of you buying an index-tracking fund, an investment manager establishes direct ownership of individual stocks that make up the chosen index through a separately managed account that you own. This may allow you to take advantage of security-level opportunities for “tax-loss harvesting,” in which declining stocks are sold to offset potential gains in other investments held in your taxable accounts, potentially helping lower your tax bill. Such opportunities are generally not available with traditional index-tracking funds.

In addition, if you have highly appreciated stock that makes up a big portion of your portfolio’s overall value, an equity exchange fund can help you diversify this potentially risky concentrated position without having to first sell it down and incur a large immediate taxable gain.

Active strategies may involve frequent buying and selling of stocks, often with a goal to beat a benchmark, but this high portfolio “turnover” can lead to more capital-gains taxes. Investing in active funds within an investment-only variable annuity (IOVA) or variable universal life (VUL) insurance policy may make sense. Both types of insurance vehicles include a tax-deferred investment account that, like in a traditional 401(k) or IRA, may defer the taxation of potential gains within the account until assets are withdrawn.

Withdrawals from an IOVA are taxed as income and can be taken penalty-free after age 59.5. VULs offer a death benefit  that may help you hedge the risk of early mortality and/or achieve a more tax-efficient wealth transfer to beneficiaries; in addition, VULs may allow you to borrow against the cash value of the policy, or, if you are willing to realize taxable gains, withdraw from or liquidate the cash value of the policy subject to possible restrictions or surrender fees in certain circumstances

As investors age, bonds become a crucial part of their investment strategy due to their potential to provide steady income and a buffer against market volatility. However, bonds are often subject to unfavorable tax treatment. To help improve after-tax returns when investing in bonds, consider:

• Municipal bonds: These fixed-income securities are issued by U.S. state and local governments and are exempt from federal income tax and, in some cases, state and local taxes as well. This can make them particularly attractive for investors in higher tax brackets.
• Indexed universal life (IUL) insurance: These insurance products offer bond-like investment returns based on the performance of a market index, with guaranteed minimum and maximum growth rates that limit potential upside and downside.

For qualified investors, alternative investments may help diversify your portfolio and enhance risk-adjusted returns, but they can entail hefty tax burdens. That said, more tax-efficient options are becoming available. Asset managers that employ tax-aware long-short strategies, for example, use tax-loss harvesting on both their “long” positions (i.e., investments made with the expectation that they will rise in value), similar to direct indexing, as well as their “short” positions, which seek to profit from a potential decline in a security’s price.

Investing in otherwise tax-inefficient alternatives within a private placement variable annuity or a private placement life insurance policy may provide an extra layer of tax efficiency. Both types of products enable tax-deferred growth, much like IOVAs and VULs for equities, but they typically have higher investment minimums.

Investors can enhance tax efficiency across their entire portfolio by implementing strategies that consider the tax implications of each investment and the tax treatment of the account or vehicle in which they are held.

One such strategy is known as asset location. It involves deciding where to place each investment to help maximize after-tax return potential. For example, investments with high growth potential and low tax efficiency, such as actively managed equity funds, would go in tax-advantaged accounts; meanwhile, tax-efficient, lower-growth-potential assets, like municipal bonds, can go in taxable accounts. This helps minimize the impact of the potential tax liabilities associated with each type of investment.

While asset location can help when you’re building wealth, other strategies, such as withdrawal sequencing and income smoothing, can be just as powerful, if not more so, in helping you tax-efficiently draw down your portfolio assets, potentially helping you make your nest egg last longer and possibly leave more to heirs.