At this time of year, it is important to review where you stand from a tax perspective to see if there are any opportunities to benefit your overall tax picture. Client First Capital’s integrated approach to wealth management lies at the intersection of investments, taxes and estate planning. As a family financial advisor, we are best positioned to understand how decisions impact all three of these areas.
In our new PDF guide titled, Top 5 Tips to Minimize Taxes on Investments During Retirement, we provide practical guidance and information on building a robust tax strategy. Below, we’ve outlined these 5 important topics and key points to consider. In our PDF guide we also include Pro Tips as well as an explanation of how Client First Capital addresses these issues. Download the full guide.
1. Take Advantage of Long-Term Capital Gains
There is a significant difference between short-term and long-term capital gains tax rates. For the vast majority, short-term capital gains are greater than long-term capital gains as they are taxed as ordinary income. Long-term capital gains have much more favorable rates and are typically 15% or 20% for most people.
Key Point: Understand timing of returns to take advantage of more favorable long-term capital gains tax rates.
2. Understand Investment Turnover
Within a mutual fund, there are many individual security transactions that are placed throughout the year. Those transactions create taxable events that are passed on to you as the investor. In 2019 the average domestic fund had an average turnover of 63%, which could be quite costly in a taxable account since those taxable events are passed through to the shareholder.
Key Point: Look at the prospectus of the mutual funds you own to understand the fund’s average turnover and tax efficiency.
3. Utilize Lot-Specific Accounting
There are two ways to track your cost for a security. One way is to keep track of each specific purchase, which is called lot basis. The other way, called average cost basis, is to average your costs across all purchases of the same security. In many instances, an average cost basis method does not allow you to maximize tax efficiencies.
Key Point: The accounting method you use to determine your cost basis can impact your overall tax rate. Further, the method used can also impact which securities you use to fund charitable gifts.
4. Be Strategic About Which Investment Account is Used to Purchase Securities
The investment account you use to purchase securities makes a difference as there are different tax rules for different accounts. For example, investments in a Roth IRA are tax deferred and tax free, making these accounts best for growth investments. IRAs and 401(k)s tend to be best for bonds. Alternatively, taxable accounts are best suited for core holdings that minimize transactions.
Key Point: Incorporating tax treatment into your investment account strategies along with risk tolerance is important.
5. Know When to Use Tax Loss Harvesting
With tax loss harvesting, you are essentially resetting your cost basis in a security for something comparable and with a lower price than what you originally paid. This strategy creates an accounting loss that can be used immediately and is effective in years where you realize a large gain (perhaps through the sale of real estate).
Key Point: When you implement a tax loss harvesting strategy, you are resetting the clock on the time horizon for capital gains. Also, it is important to choose the right security when implementing this strategy so as not to trigger a wash sale.