Oxstones Investment Club™By MATTHEW SCOTT, DailyFinance.com,
The equation is simple: Reducing the amount of money you pay in taxes boosts your investment portolio’s returns. To help you take action before the year runs out, DailyFinance asked two investment-portfolio managers for high-net-worth individuals to share some of the tax strategies they use to help their clients keep more of what their investments earn.
Justin Fulton, a senior client strategist at Signature, and Chip Cobb, senior vice president at Bryn Mawr Trust Asset Management, revealed the following tax tips:
1) Realize capital gains at the current 15% rate. Perhaps the top tax consideration for investors this year is the uncertainty surrounding the future of capital-gains tax rates, or the taxes you pay when you sell or cash out of an investment. Currently set at 15%, rates could go up substantially in the future (Congress is expected to vote on whether or not to raise rates within the next three months), so investors should try to take advantage of that rate while it’s still in place. For investors who may need to sell an investment, “now may be a good time to go ahead and bite the bullet and realize those gains before the end of the year, because at least you know you’ll be getting a 15% tax rate in case the Bush tax rates are not extended,” Fulton says.
2) Take advantage of the tax-loss-carry-forward rule. Investors can neutralize the tax consequences of capital gains by matching them up against other investment losses under what’s called the tax-loss-carry-forward rule. Under this rule, investors who suffered major stock losses in 2008, for example, are allowed to count some of those investment losses up to seven years into the future to offset taxable gains in more profitable years. But this tip might come too late for some investors who did very well in 2009, when many investors had major gains in a bounce-back year that could have wiped out many of the losses they could have carried forward to 2010. “You’ve got to be very specific at the end of the year as to whether or not you have a carry forward from years prior,” he says.
3) Sell your losing investments. If you’re ready to sell some profitable investments, it’s also a good time to sell some losing investments to counteract those capital gains (and reduce the related capital-gains taxes). Investors can always buy the investment back in 30 days under the wash-sale rule, if they really want to own that particular security.
4) Don’t buy new mutual funds right before year-end capital distributions. Many mutual funds make their capital gains distributions — sort of a dividend — in November and December, so it would seem like this might be a good time to buy. But in actuality, it’s better to avoid the taxes from this by buying after these distributions are made. “You don’t want to own the fund for a short period of time and then have to pay tax on something that you haven’t had the chance to get appreciation on,” Fulton says. So check with your account manager to make sure you avoid this fee if you are making changes to your portfolio.
5) Rebalance your portfolio with tax efficiency in mind. When rebalancing your portfolio, Fulton advises placing less tax-efficient investments — such as bond funds, which pay ordinary tax rates on interest income — into non-taxable accounts, such as traditional IRAs. Then place more tax-efficient investments, like stock-index funds, into your taxable accounts. This will lower the number of investments on which you’re paying capital-gains taxes.
6) Consider tax-advantaged funds for your portfolio. Many mutual funds include tax-free, tax-deferred or tax -reduced investments, which come with incentives to encourage more investment. These funds can be very attractive, especially for investors with taxable accounts, Cobb says. However, the uncertainty surrounding the capital-gains tax law extends into how these funds will be handled at tax time in the future, so he wouldn’t recommend buying them on that basis alone. “If you are in them, hold on to them until you know where that tax situation is going,” says Cobb, who is hesitant to buy into those funds until he finds out whether the tax breaks they provide will be permanent. “If they make them permanent tax breaks, then they are very attractive at that point, but if we know that they are going to go away, then they are going to be no more attractive than anything else.”
7) Convert your traditional IRA into a Roth IRA. If you were considering converting from a traditional IRA to a Roth IRA, do it now because this is the only year that you can still spread the tax consequences of the conversion over two years (2010 and 2011). And then, of course, you won’t have to pay taxes on withdrawals from the account ever again. “If you do [the conversion] anytime in 2011, you will be subject to paying the tax all in one year,” Cobb says. “The incentive is to do it this year.”
8) Convert nondeductible IRA contributions into a Roth IRA. If you are going to make a nondeductible contribution to your IRA, make it count more by making the contribution and then converting it into a Roth IRA. You’ll pay the tax on the new contribution, but have a vehicle for future contributions that is more tax friendly, Fulton says.
Tags: investment strategies, IRAs, net after tax returns, realized capital gains, Roth IRA, tax efficient investments, tax rates, tax strategies, tax-loss carry forward rule, Traditional IRA