There is a classic saying out there that typically reads something like:
Some people seem to be allergic to paying taxes. Let me show you an example. This is from a post on the Bogleheads forum.
“Is there anything more tax-efficient than index funds? I have some money that I'm planning to leave to heirs, and it is currently invested in two index funds (Vanguard Total Stock Market Index Fund, Vanguard Total International Index Fund). I'm happy with the funds and the 100% equity allocation.
However this means every year there is a sizable tax bill due to the dividends, and I end up paying about 24% of the dividends in tax because of the mix of qualified and unqualified. But I don't need these dividends and just reinvest them.
Is there something that would give me a similar long term risk/return result without the yearly tax burden?”
Yes, some investments will result in a lower tax bill, but not many of them. Here is a list of investments that are likely to have a lower tax bill than VTI/VXUS:
- Specialized “ex-dividend” mutual funds
- Municipal bonds
- Individual non-dividend paying stocks, like Berkshire Hathaway (although it can be argued Berkshire is paying the tax bill for you)
- Cryptoassets like Bitcoin (no dividends, and they can be tax-loss harvested without a partner)
- Precious metals (although they're taxed at a higher “collectibles” rate when sold)
- Equity investment real estate, as long as depreciation covers the income
- Investments with lower expected returns
You can also mess around with asset location by placing investments inside a low-cost variable annuity or by doing Roth conversions. However, all of these investments and techniques have downsides compared to just buying boring old VTI and VXUS. VTI is already SUPER tax-efficient. Yes, you may pay 24% of those dividends in tax—I pay something like 20% federal + 3.8% PPACA + 4.55% state = 28.35% on them since they're almost completely qualified (less than 3% was non-qualified in 2024 per my 1099).
But on how much of the return are you actually paying 24%? The current dividend yield of VTI, as we publish this, is 1.08%. If the long term return is 10%, only 1.2%/10% * 24% = 2.59% of the return is going to the tax man. You're keeping more than 97% of it and passing it on to your heirs tax-free due to the step up in basis. That's less than one-third of what many financial advisors would charge you to manage your assets, and you'd still pay the tax bill (and probably a higher one) if you had one.
If this is what you're worried about, you definitely have TDS—Tax Derangement Syndrome.
RMD Allergy
Another way TDS manifests itself is with a fear of Required Minimum Distributions (RMDs). I'm amazed at what some people will do to lower their RMDs. People act as though big RMDs are a bad thing. Nobody complains about having a big, fat six- or seven-figure taxable income prior to retirement, but somehow it becomes a bad thing after retirement? Think about all of the things people do to minimize their RMDs:
- Ill-advised Roth conversions
- Deliberately earn low returns inside tax-protected accounts
- Remove money from tax-protected accounts earlier than required
- Avoid contributions to tax-protected (and asset-protected) accounts entirely
Give me a break. Most people should be spending their entire RMD. RMDs only apply to part of your portfolio, and “just spending the RMD” is considered by most experts to be an overly conservative method of spending from your portfolio. Get that? You're very unlikely to run out of money if all you're spending is your RMD. And you're talking about not even doing that.
If an RMD is a bad thing in your life, you have far more money than you need, and you can safely give a whole bunch of it away now to your heirs and/or charity. In fact, the best way to give to charity once you are of RMD age is to use Qualified Charitable Distributions (QCDs). These allow you to give with pre-tax dollars, and they take the place of RMDs, at least up to $100,000 per year indexed to inflation (in 2026, it's $111,000). If you've got an RMD of more than $111,000 at age 75, that suggests tax-deferred accounts of at least $2.7 million. And you've probably got some Roth money, some taxable money, some Social Security, and maybe a pension, too. Congratulations, you're rich!
More information here:
Do You Need a ‘Tax Strategist?’
10 Ways to Avoid (or at Least Delay) Capital Gains Taxes
Investments Designed Primarily to Generate Losses
Some people put money into investments HOPING for losses. I'm not talking about losses that are mostly just paper losses, like the depreciation you might take to shield the income on a rental property for a while. I'm talking about “tax shelters” and people paying all kinds of money to somebody to do tax-loss harvesting for them. “Direct indexing” is the latest version of this, and maybe if you can get the fees low enough, the tax losses generated can be worth more than the fees to you. But “tax shelters” have been sold to doctors for decades in real estate, oil and gas, or weird schemes like buying tribal tax credits. Yes, they lowered their taxes, but mostly they did that through having poor returns. Just like sitting at home instead of going to work lowers your tax bill, so does having crummy investment returns.
And with tax shelter-type investments, you usually end up with plenty of hassle and illiquidity, too. If you're buying an investment primarily for tax reasons, you're probably making a mistake. The investment itself has to generate a solid return. Any tax benefits should just be icing on the cake. The best way to lower your taxes is to actually lose money. Just like giving money to charity doesn't make you richer, neither does losing money. After-tax, you're coming out behind.
Insurance Products
One of the classic techniques for selling whole life insurance is to push the “tax benefits.” Never mind that the only unique tax benefit of whole life is the ability to take your principal out before your earnings via partial surrenders. The other benefits are available from some (tax-deferred growth) or all (tax-free death benefit, ability to borrow against it tax-free) other investments or accounts. The substantial downsides of “investing” in whole life insurance (high costs, having to qualify for and purchase a death benefit, low returns, ordinary income tax treatment on gains) pretty much outweigh any tax benefit.
Annuities are another product usually designed to be sold for high commissions rather than bought. Tax-deferred growth is good, but high fees, ordinary income tax treatment instead of better long-term capital gains tax treatment, and “Last In, First Out” (LIFO) tax treatment are not.
Both products, along with all their variations, are often mistakenly purchased by people with TDS.
More information here:
20 Ways to Lower Your Taxable Income for High Earners
3 Big Tax Deductions for Doctors
Overuse of Roth Accounts
TDS also shows up with Roth contributions and conversions. While decisions about whether to make Roth or traditional contributions or whether to do a conversion are perhaps the most complicated decisions in personal finance, extreme amounts of Roth contributions or conversions are likely to be an error. If that money is going to be withdrawn by you or an heir in a lower tax bracket or, worse, by a charity, Roth was definitely the wrong choice.
Failure to Compare Estate Taxes to Income Taxes in Irrevocable Trusts
When you use an estate tax technique like an Intentionally Defective Grantor Trust (IDGT), such as the Spousal Lifetime Access Trust (SLAT) we use, your family may be trading income taxes for estate taxes. Getting that money out of your estate may or may not save you estate taxes, but it does eliminate the step up in basis at death. Forming one of these when you would not even have estate tax due anyway could be a huge mistake.
Don't get me wrong. Understanding the tax code is important. If you can reduce your taxes without impeding the way you wish to live your financial life, go ahead and do so. But beware of TDS and don't let the tax tail wag the investment dog. There are worse things in life than having a large tax bill, and there is probably something the government does with the tax money that you support. Just pretend all of YOUR tax money is going toward that. If you have a six- or even a seven-figure tax bill, it means you earned a lot of money. Celebrate that instead of mourning how much you paid in taxes.
What do you think? What other ways do you see TDS manifest itself? What have you done to avoid it?