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By Christine Benz and Jeremy Glaser | 02-18-2016 01:00 PM

4 Best Practices for Building a Tax-Efficient Portfolio

Let your time horizon lead the way, employ tax-efficient equity strategies, make sure not to trigger your own taxable events, and maintain tax diversification throughout retirement, says Morningstar's Christine Benz.

Note: This video is part of Morningstar's February 2016 Tax Relief Week special report.

Jeremy Glaser: For Morningstar, I'm Jeremy Glaser. It's Tax Relief Week here on Morningstar.com, and I'm joined today by Christine Benz--she's our director of personal finance. We're going to look at four best practices for building a tax-efficient portfolio.

Christine, thanks for joining me.

Christine Benz: Jeremy, it's great to be here.

Glaser: When we are talking about tax-efficient portfolios, we're usually talking about taxable accounts. Why should investors even consider taxable accounts, given the built-in advantages of an IRA or a 401(k)?

Benz: That's a really good question. The first reason is liquidity or flexibility. You might have some short-term or even intermediate-term goals that you need to finance prior to retirement, and investing in a taxable account will give you, by far, the most flexibility in terms of pulling your assets out. You also have the flexibility to invest in a lot of different investment types, whereas there are some strictures certainly for investing in a 401(k) where you are usually choosing from a preset menu. And even with an IRA, even though you have a huge degree of latitude about what you can choose for that IRA, there are at least some strictures regarding what you can invest in inside of an IRA.

So, flexibility and liquidity would be two key reasons. Another key reason would be simply for higher-income investors who are already maximizing their contributions to those various tax-sheltered account types. The taxable account may be their only option at that point. Finally, I would say, especially for people who are accumulating assets for retirement. There is some advantage to coming into retirement with some assets in a taxable account. The reason is that if you have assets in that taxable account that are eligible for capital gains treatment, that's pretty favorable--especially right now with capital gains rates as low as they are.

So, in fact, pulling money from a taxable account will generally be preferable--in terms of your income tax in a given year--to pulling money from a traditional IRA or a traditional 401(k) where you'll pay ordinary income tax rates on those distributions.

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