Strategies Designed to Protect Growth From Tax Drag in the Accumulation Years
When it comes to building wealth, most investors are conscious of returns, risk and timing. But the market isn’t the only force shaping long-term wealth.
Compounding is one of the most powerful tools investors have; small gains layered over time can snowball into life-changing results. The catch is that compounding only works if those returns are allowed to stay invested. Taxes on dividends, interest and realized gains quietly skim off growth each year, slowing the very engine that is meant to accelerate it. This drag adds up and can cost you more than management fees or one-off market swings.
We’ve seen that while seasoned investors are acutely aware of tax drag, our clients that are growing wealth outside of maximizing their 401(k)s and starting to put away substantial savings may not have the tenure or wealth built yet to realize that smart account structuring and a tax-aware strategy can meaningfully help to protect their compounding power.
1. What is Tax Drag, and Why Does it Matter?
Tax drag is the hidden toll that taxes take on your investment returns, meaning the gap between what your portfolio earns and what actually stays invested to keep compounding.
Example:1 A portfolio earning 7% annually may only net 5.6% after a 20% long-term capital gains tax. That 1.4% difference may seem small, but stretched across 30 years on a $1 million portfolio, it could mean a shortfall of more than $1.3 million in lost growth.
Over decades, even a 1–2% drag each year may compound into significant money by retirement. So while tax drag doesn’t get the attention that market volatility does, without proactive strategies, it could steadily eat away at the compounding engine that wealth depends on to keep growing.
2. Tax Location: Putting Assets Where They Work Hardest
One of the most overlooked levers for wealth builders in their 30s, 40s and 50s isn’t what they invest in, it’s where they hold those investments. Placing the right assets in the right accounts can materially change net returns over decades. While no two clients or situations are the same, we’ve outlined below some guiding principles so you can start thinking about how you might structure your assets:
- Taxable Accounts (Brokerage): Best suited for tax-efficient assets. Think ETFs, individual equities held long-term or municipal bonds. These enjoy favorable capital gains treatment and qualified dividend rates. For high earners, taxable accounts also create optionality — e.g., liquidity for opportunities like a real estate purchase, a business investment or an early retirement window.
- Tax-Deferred Accounts (401(k), Traditional IRA, private equity, etc.): A natural home for tax-inefficient assets like high-yield bonds, REITs or actively managed funds that spin off taxable income. Growth is tax insulated until withdrawal, reducing the annual tax bite. But remember: these accounts are tax deferred and fund future retirement income, and will be taxed accordingly. Every dollar comes back out as ordinary income.2
- Tax-Exempt Accounts (Roth IRA, Roth 401(k), HSA): Excellent for long-term growth. Roth accounts are where you want to hold your highest-upside, most aggressive assets — e.g., small-cap equities or growth stocks — because every dollar of future gain can be tax-free if the rules are met. For clients who expect higher tax brackets later, the “backdoor” Roth or “mega backdoor Roth” can be particularly powerful. Another strategy that some of our clients utilize is to convert traditional IRAs to Roth IRAs, meaning they pay tax at the time of conversion and then their investments grow tax-free from there. And for those seeking to take advantage of this benefit, but limited by income and/or contribution limits, life insurance may be a viable solution for larger tax-free accumulation to distribute in retirement.
Client Example:3 We recently worked with a law firm partner who was investing in private equity funds in her taxable brokerage account generating six figures of annual taxable income, and in ETFs in her tax-deferred IRA. We suggested that going forward, she continue building her private equity fund position in the IRA and the ETFs in the taxable brokerage account given their capital gains tax-deferred status (regardless of account type). The result wasn’t a more aggressive portfolio; it was simply smarter placement to plug her tax leak and let compounding work more efficiently.
Bottom line: Aligning asset type with account type is how high earners keep more of what they’ve already worked to build.
3. Smarter Planning with Azura
Tax drag doesn’t show up in the headlines, but over time it could be one of the most damaging forces working against compounding. The more wealth you accumulate, the larger your tax liability can become. The good news is that it’s manageable; with the right structure, you can work toward keeping more of what you earn and let time do its work.
At Azura, we help clients:
- Quantify potential tax drag and identify inefficiencies.
- Match investment types to the right account structures.
- Avoid common traps like selling stocks and triggering tax when, instead, they might more efficiently draw a line of credit against the portfolio on a non-taxable basis (also allowing the investments to continue growing uninterrupted, and offsetting taxable qualified dividend income with loan interest).
- Leverage tax-efficient tools such as low-turnover ETFs, direct indexing and disciplined tax-loss harvesting.
Our goal is to build plans for our clients where taxes don’t quietly erode the wealth they’ve worked to build. With the right approach, you can preserve more growth, protect your compounding engine and create a framework for sustainable wealth. If you’re ready to stress test your current structure or design one with tax efficiency at its core, Azura can help you move from good intentions to better results.
1 This hypothetical example is for illustrative purposes only. This is not a prediction or guarantee of actual results. This example is not intended to represent the value or performance of any specific product.
2 The order in which you withdraw your assets in retirement, known as sequencing, is critical to maintaining longevity in your retirement years. If you’re interested in learning more about distribution, ask your Azura advisor for our article on the topic.
3 This hypothetical example is for illustrative purposes only. This is not a prediction or guarantee of actual results. This example is not intended to represent the value or performance of any specific product.
Any discussion of taxes is for general information purposes only, does not purport to be complete or cover every situation, and should not be construed as legal, tax or accounting advice. Neither MML Investors Services, LLC nor any of its subsidiaries, employees or representatives are authorized to give legal or tax advice. Clients should confer with their qualified legal, tax and accounting advisors as appropriate.