The 7 Best Tax-Smart ETFs to Buy Today

ETFs to buy - The 7 Best Tax-Smart ETFs to Buy Today

Source: Pictures of Money via Flickr (Modified)

With the start of the New Year finally upon us, it can mean only one thing — it’s tax season. And while the new Republican tax bill does hold plenty of promise, the reality is, most tax analysts have no idea what the long-term effects on the average Joe will be. Ultimately, it means investors still need to be as tax efficient as it comes with their portfolios.

And luckily, exchange-traded funds (ETFs) can help on that front.

By nature, ETFs tend to be more tax efficient than mutual funds or other investment vehicles. Moreover, ETFs allow many regular investors to tap into asset classes and sectors of the market that tend to be more tax friendly than others. Putting the two together provides plenty of tax smarts. In end, what you keep is more important than what you actually make.

With that in mind, here are seven tax-smart ETFs to buy that you can add to your portfolio to keep Uncle Sam at bay.

Tax-Smart ETFs to Buy: Vanguard Total Stock Market ETF (VTI)

Tax-Smart ETFs to Buy: Vanguard Total Stock Market ETF (VTI)Expense Ratio: 0.4%, or $4 annually per $10,000 invested

One of the best ways for ETFs to help against hefty tax bills comes down to their index-hugging natures. And those funds that hold the broadest indexes, are the most tax-efficient. That’s because the fund doesn’t have to sell/buy stocks that have come in and out of the index.

Well, you can get any broader than the Vanguard Total Stock Market ETF (NYSEARCA:VTI). That’s because it owns everything.

VTI tracks the CRSP US Total Market Index. That gives investors exposure to large-, mid- and small-caps in the United States. As in all 3,624 stocks trading in the United States. The underlying index is designed to provide exposure to 100% of the investable marketplace in the U.S.

As a result, VTI has been amazingly tax-efficient when it comes to capital gains. It just doesn’t need to sell stocks in order to refresh its index; they’re already all in there. This helps make it a great core holding for a taxable account looking for equity exposure.

Tax-Smart ETFs to Buy: iShares National Muni Bond ETF (MUB)

Tax-Smart ETFs to Buy: iShares National Muni Bond ETF (MUB)Expense Ratio: 0.25%

Under the new Republican tax plan, municipal bonds retain their tax-free status. That’s great news as munis remain one of the best ways to keep taxes to a minimum. Municipal bonds are issued by local and state governments and agencies in order to help fund daily activities or special projects. The best part is they are free from federal and sometimes state/local taxes.

The king of the muni ETFs is the $9.6 billion iShares National Muni Bond ETF (NYSEARCA:MUB).

MUB tracks nearly 3,500 investment-grade municipal IOU’s. that provides plenty of diversification benefits as well as plenty of tax-free income. MUB currently yields 2.12%. On the surface that may seem small. However, when factoring in taxes, someone in the highest tax brackets would need to earn nearly 4% to get the same amount of income.

That makes MUB a powerful ally for those investors looking to live off their investment income. So many investors forget about the tax man when it comes to dividends and other income plans.

Tax-Smart ETFs to Buy: VanEck Vectors High-Yield Municipal Index ETF (HYD)

Tax-Smart ETFs to Buy: VanEck Vectors High-Yield Municipal Index ETF (HYD)Expense Ratio: 0.35%

Need more tax-free income? If you’re willing to take on a bit more risk, the VanEck Vectors High Yield Municipal Index ETF (NYSEARCA:HYD) is for you. Just like the regular bond space, not all municipal bonds are created equal. Creditworthiness varies from state-to-state or town-to-town. That means that some issuers are considered “junk.”

HYD tracks the non-investment grade swath of the municipal bonds market — currently 1,600 different bonds. These include one-off and special project revenue bonds as well as munis from towns with less-than-stellar credit. About 75% of its portfolio is in these bonds, while 25% is rated Baa/BBB-0-, which is the lowest investment grade rating. ETF sponsor Van Eck cites this as needed for “liquidity and balance.”

What all of this does is boost the tax-free yield of the ETF.

The ETF currently yields a juicy tax-free 4.39%. That’s about 6.44% for someone in the top tax bracket. Now, for some investors, HYD’s dividends could be subject to the alternative minimum tax (AMT). However, for most of us, this isn’t a real problem.

And that makes HYD a great choice for tax-smart high income from an ETF.

Tax-Smart ETFs to Buy: Global X MLP ETF (MLPA)

Tax-Smart ETFs to Buy: Global X MLP ETF (MLPA)Expense Ratio: 0.45%

Master Limited Partnerships (MLPs) also kept their deferred tax status in the Republican tax plan. MLPs are considered pass-through securities that have a unique feature that their distributions are considered returns of capital. That is, they reduce the cost basis for their owners. That defers taxes and then MLP owners will have to play larger capital gains tax. That tax-deferral can be a powerful tool.

The Global X MLP ETF (NYSEARCA:MLPA) can be a great way to harness that tool.

The ETF tracks a basket of MLPs. These include sector stalwarts like MPLX LP (NYSE:MPLX) and EQT Midstream Partners LP (NYSE:EQM). The best part was in both 2015 and 2016, MLPA’s distributions were 100% considered return of capital; 2017 is expected to be the same.

What that does is make MLPA a powerful way to defer some additional taxes beyond an IRA or 401k account. For investors, that’s huge. Almost as huge as MLPA’s big 7.67% yield.

Tax-Smart ETFs to Buy: iShares Short Maturity Municipal Bond ETF (MEAR)

Tax-Smart ETFs to Buy: iShares Short Maturity Municipal Bond ETF (MEAR)Expense Ratio: 0.25%

Holding cash for short-term or medium-term needs does come with some tax risk. After all, the interest you receive on your savings account or CD is subject to taxes. And that interest is reported at ordinary income rates. For those investors saving up for a larger purchase or using a bucket strategy for their living expenses, those taxes can be a hefty pill to swallow.

That’s where the iShares Short Maturity Municipal Bond ETF (BATS:MEAR) comes in handy.

MEAR is a money-market-like ETF that consists of extremely short-term municipal bonds or those securities with maturities of 180 days to 1.5 years. What that does is provide a slightly better yield than a savings account — currently at 1.01% — while still granting the tax-free benefits of muni bonds.

And considering that MEAR’s share price has hovered around $48 to $50 since its inception, that gives it cash-like qualities.

For investors looking to save money and save money on taxes, MEAR is a no-brainer.

Tax-Smart ETFs to Buy: SPDR Portfolio S&P 500 Growth ETF (SPYG)

Tax-Smart ETFs to Buy: SPDR Portfolio S&P 500 Growth ETF (SPYG)Expense Ratio: 0.04%

Another great way to get your equity fix in a taxable account- growth stocks. Typically, growth stocks do not pay big or any dividends at all. And if you hold them for quite a while, capital gains taxes are lower. That makes them perfect for a taxable account.

A great way to do just that is through the SPDR S&P 500 Growth ETF (NYSEARCA:SPYG).

As the name implies, SPYG tracks all the growth stocks in the S&P 500. That provides plenty of capital gains and high returns for investors. The best part is investors have been able to control when they pay those gains. Just take a look at the ETF’s distribution history. Not a single short- or long-term capital gain payment in nearly 20 years. That’s amazingly tax-efficient for any ETF.

What’s even better is that SPYG comes with a nearly 10% annual return over the last decade.

For investors looking to score some big gains in their taxable accounts, SPYG is one ETF that needs to be on their lists.

Tax-Smart ETFs to Buy: PowerShares Financial Preferred Portfolio (PGF)

Tax-Smart ETFs to Buy: PowerShares Financial Preferred Portfolio (PGF)Expense Ratio: 0.63%

Investors looking for even more tax-efficient income from their portfolios may want to focus their attention on preferred stocks. Many of these hybrids do qualify for the lower tax rate of just 15%. While that’s not exactly tax-free, it’s still better than the ordinary income rates on junk bonds. And investors are getting roughly similar yields in the 5% to 8% range.

But not all preferred stocks are the same.

That’s what makes the PowerShares Financial Preferred Portfolio (NYSEARCA:PGF) the correct tax play here.

PGF tracks preferred stocks issued by financial firms. This includes banks and insurance firms. That’s an important distinction as it allows the ETF to pay out only ordinary income distributions … the kind that is taxed at just 15%. Since its inception, PGF hasn’t paid out any capital gains. Investors just get a steady monthly dividend that is taxed at lower rates. That dividend, by the way, is currently a 5.63% yield.

For investors looking for a bit more “oomph,” the PowerShares ETF is the way to go.

As of this writing, Aaron Levitt was long SPYG and PGF.

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