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5 ETFs to Lower Your Taxes

These ETFs can be great at lowering your tax bill

By Aaron Levitt, InvestorPlace Contributor

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With the start of the new year in sight, it’s time to begin thinking about that dreaded five-letter word — taxes. No one likes paying them, and reducing their overall tax burden is important when it comes to overall long-term returns. After all, the less you send to Uncle Sam, the more you have for spending and additional compounding. Luckily, there are some ways to lower your tax bill when it comes to your portfolio.

And that’s thanks in part to a hefty dose of exchange-traded funds (ETFs).

Thanks to their structure and the creation/redemption process behind it, ETFs are naturally more tax-efficient than mutual funds. Moreover, ETFs allow for investors to tap into and hone in on some asset classes that are naturally more tax-friendly. The combination of the two allows investors the ability to lower their overall tax bills from their portfolios. That fact should make everyone happy. But not all ETFs are worthy of tax-efficiency.

To that end, here are five of the best ETFs for lowering your tax bill.

ETFs to Lower Your Taxes: SPDR Nuveen Barclays Municipal Bond ETF (TFI)

SPDR Nuveen Barclays Municipal Bond ETF (TFI)

Expense Ratio: 0.23%, or $23 annually per $10,000 invested

Perhaps the best way to avoid taxes is investing in asset classes that are considered “tax-free.” And you can’t get better than municipal bonds. Issued by state and local governments/authorities, muni’s are generally free from Federal taxes and in many cases, free from state taxes as well. For investors, this ability to generate tax-free income can be a godsend. And for higher earners, the effect is even better.

A great starting point could be the SPDR Nuveen Barclays Municipal Bond ETF (NYSE:TFI).

TFI tracks the Barclays Municipal Managed Money Index. This benchmark looks at long-dated, fixed-rate municipal bonds with credit ratings of at least Aa3 or AA-. That means its focused only investment grade debt. There’s no junk in here. Moreover, the ETF does not track/hold bonds subject to Alternative Minimum Tax (AMT). For higher earners, the AMT can provide a nasty tax surprise. All in all, TFI holds 3,737 different bonds.

That huge swath of muni bonds allows the ETF a good 2.3% dividend yield. And while may sound low, remember this is tax-free. For someone in the highest tax bracket, you’d need to earn nearly 5% to get the same amount of income after taxes.

With expenses of just 0.23%, or $23 per $10,000 invested, TFI could be one of the best ETFs to cut your tax bill to zero and pick up some much-needed income.

ETFs to Lower Your Taxes: iShares Short Maturity Municipal Bond ETF (MEAR)

iShares Short Maturity Municipal Bond ETF (MEAR)

Expense Ratio: 0.25%

Cash is thought of a safe asset, but holding it can come with some tax consequences, and Uncle Sam still wants his cut. By law, all interest earned on a savings account is taxable — even if it is just a few dollars per year — and that tax is at your standard income rate. Again, higher-earning investors can get hit simply holding money in a savings account. Luckily, ETFs can help here as well.

The iShares Short Maturity Municipal Bond ETF (NYSEARCA:MEAR) is as close to a tax-free cash substitute as they come.

MEAR is considered a short-term bond ETF. But unlike, it’s sister fund — the iShares Short-Term National Muni Bond ETF (NYSEARCA:SUB) — MEAR knocks the maturity/duration profile even shorter and is more like a tax-free money market fund. The ETF is actively managed and the team at BlackRock focuses on bonds with maturities of 180 days to 1.5 years. Right now, the average maturity profile is just around 230 days.

That short maturity profile allows it to function very much like a cash holding. And in fact, the ETFs share price has stayed pretty constant between around $48 and $51 since its inception. Meanwhile, investors pick up a 1.75% SEC yield. That’s basically what a savings account is paying these days anyway, and MEAR is tax-free. That’s huge for higher-income savers looking to lower their tax bills.

With an expense ratio of just 0.25%, MEAR is one of the best ETFs to tell Uncle Sam where to stick it.

ETFs to Lower Your Taxes: Invesco QQQ (QQQ)

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Invesco QQQ (QQQ)

Expense Ratio: 0.2%

ETFs holding equities can be pretty tax-efficient as well. The key is to focus on certain kind of stocks. And this case we’re talking growth stocks.

Unfortunately, dividends are a taxable event, and every year you need to send the Feds their portion. Historically, growth stocks haven’t been known for their dividends. Which is good news for tax-efficiency. If you buy a stock like Google (NASDAQ:GOOG, NASDAQ:GOOGL) — which does not pay a dividend — and hold it for a long time before selling it, you get to defer taxes. So, growth-stock ETFs have long been some of the best places to actually lower your taxes. After all, the long-term capital gains rate is just 15%.

And when it comes to growth ETFs, the Invesco QQQ (NASDAQ:QQQ) is the mother of them all.

The $61 billion ETF tracks the NASDAQ 100 Index. This index holds roughly 100 of the largest U.S. and international non-financial stocks listed on the Nasdaq Index. The Nasdaq is known as a home to some of the biggest tech and growth names in the U.S. As a result, “The Cubes” represents one of the best ways to add growth stocks and their typically lower taxes to a portfolio. Also adding to its tax appeal is lower bid/ask spreads thanks to its swift trading volume.

And while the QQQ does pay a dividend, it’s small, with a 12-month distribution rate of 0.83%. The tax effects of that small yield are inconsequential even to higher earners. All in all, the QQQ’s represent one of the best ETFs to get equity exposure and lower taxes.

ETFs to Lower Your Taxes: Vanguard Total World Stock ETF (VT)

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Vanguard Total World Stock ETF (VT)

Expense Ratio: 0.1%

ETFs tax-efficiency also shines when they are doing what they do best. And that’s being as broad and cheap as possible. The broadest of them all could be the Vanguard Total World Stock ETF (NYSEARCA:VT).

VT tracks everything. Seriously. Every stock in the world. The ETF’s underlying index, the FTSE Global All Cap Index holds large-, mid- and small-cap stocks across 47 countries. That includes both developed and emerging markets. All in all, VT holds more than 8,200 stocks and covers more than 98% of the global investable market capitalization.

Because it always owns everything, there’s no real index rebalancing- which can lead to capital gains. As a result, VT has a super low turnover rate. This has allowed VT to be one heck of a tax-efficient ETF and it has never paid out a capital gain since its inception. And while the 12-month dividend yield at 2.3% is higher than the previously mentioned growth-stock focused QQQ, those dividends are considered qualified and taxed at the lower 15% rate.

The icing on the cake is as a Vanguard ETF, VT is dirt cheap to own at just 0.1% in expenses.

ETFs to Lower Your Taxes: Schwab U.S. Dividend Equity ETF (SCHD)

Schwab U.S. Dividend Equity ETF (SCHD)

Expense Ratio: 0.07%

Speaking of qualified dividends, anyone looking for income from stocks can find solace in ETFs. Stocks structured as REITs or MLPs are typically found in many dividend ETFs because of their high yields. The problem is that their distributions don’t count under the qualified dividend rules and are taxed at income rates. You want your dividends to be considered qualified. Depending on your tax bracket, you could pay as little as 0% on these dividends.

For those investors in low-to-mid tax brackets, this great news.

One of the best ETFs to take advantage of this is the Schwab U.S. Dividend Equity ETF (NYSEARCA:SCHD). SCHD uses a fundamental index that looks for high-yielding companies with a record of consistently paying dividends and maintaining strong financials. SCHD will screen for cash flows, total debt, return on equity, dividend yield and five-year dividend growth rates. The 100 best scoring stocks are selected for the ETF. Top holdings include stalwarts like Exxon (NYSE:XOM) and Johnson & Johnson (NYSE:JNJ).

The best part is that the fund holds no REITs, MLPs, preferred stocks or convertibles stocks. That means its payouts meet the requirements for qualified dividends.

For those investors looking to boost their income — SCHD yields 2.6% — while paying low-to-potentially zero in taxes, the ETF is a great pick. And it looks even better when you consider its low expense ratio of 0.07%.

At the time of writing, Aaron Levitt held a long position in VT.


Article printed from InvestorPlace Media, https://investorplace.com/2018/12/5-etfs-to-lower-your-taxes/.

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