Posts Tagged ‘taxes’

It’s Tax Season: Avoiding Big Taxes on Your Investments

Monday, January 25th, 2016

tax season

Since tax season is in full swing, now is the appropriate time to do a mini series of tax-related articles, right? That’s what we thought, so over the next few weeks, that’s what we’ll be doing. To kick things off, let’s go over taxes on your investments. Taxes can eat into your investment performance in ways that you can’t imagine, and definitely don’t anticipate. Thankfully, there are ways to improve your returns while keeping Uncle Sam at bay.

Developing a “tax-efficient” investment strategy should be on the top of your money resolutions this year if you don’t already have one in place. It’s relatively easy to do once you identify some problem spots.

First off, where you hold your investments makes a big difference in how your investments will be taxed. For long-term savers, 401(k)s, 403(b)s, Roths and 529 college savings plans all allow you to compound your money tax deferred.

While you’ll pay taxes on contributions to Roth 401(k)s and IRAs, you can take withdrawals tax free, but they are subject to certain conditions. If you hold money in the account at least five years and you’re 59 1/2 or older, there’s no tax on what you take out.

Here’s where it gets troublesome. Anything held outside of a qualified retirement account can trigger capital gains, dividend, or ordinary income taxes. That’s what I mean by “tax efficiency.” If you can keep money in a retirement or 529 account, you don’t have to worry about funds you plan to leave alone for a while.

The act of keeping money outside of tax-deferred accounts can cost you plenty, and there are an array of taxes that may apply:

  • Ordinary dividend and net short-term capital gain distributions—on sales of securities held 12 months or less—are taxed at the investor’s ordinary income tax rate, currently a maximum of 39.6%.
  • Long-term capital gain distributions—on sales of securities held more than one year—are taxable as long-term capital gains.
  • The maximum tax rate on “qualified dividend” income and long-term capital gain distributions for most investors is 15%, but increases to 20% for high-income individuals.
  • In addition, high-income taxpayers are subject to the 3.8% health care tax on “net investment income.”

For those who also invest in taxable accounts— about 47% of bond and stock mutual fund assets are held in such accounts— should consider their asset location strategy as well as their asset allocation strategy. This approach should enhance tax efficiency (which measures the difference between pretax and after-tax returns) and potentially improve after-tax returns.

What can you do to save on taxes outside of deferred accounts? Keep in mind that vehicles paying dividends or long-term capital gains are taxed at a lower rate than investment returns taxed at ordinary income.

If buying mutual, or exchange-traded funds, also consider the funds’ “tax efficiency ratio”. Generally the higher the ratio, the lower your tax bill from owning that fund. As a rule, passive index funds, which buy and hold a basket of securities, will have a higher tax-efficiency ratio than an actively managed fund.

Make sure to consult with a registered investment advisor or a certified financial planner before making big changes to your tax strategy, or if you have questions on what to do with your portfolio to lower taxes.

Getting a Head Start on Your 2016 Taxes

Monday, December 21st, 2015

taxes-be-like

Whether you’re pre-distribution or post-distribution age and have an IRA, tax-wise, things can get complicated fast. There’s a lot that goes into getting taxes ready for some of us, so why not save yourself the panic in April and get prepared now?

Is a Roth IRA for you?

With a traditional IRA, contributions are made up of pre-tax dollars, but you’ll pay taxes on future withdrawals, and traditional IRAs are subject to required minimum distribution, or RMD. In a Roth IRA, contributions are made with post-tax dollars, but future withdrawals are tax free and aren’t subjected to required minimum distribution rules.
If you hold an asset in your IRA that could have significant growth potential, like real estate or a startup, it might make sense to convert to a Roth IRA. You will pay taxes on the amount you convert, but your earnings will then grow tax free indefinitely.​

Don’t forget about your business

Contributions to SEP-IRAs, SIMPLE IRAs and solo 401Ks reduce your tax bill now and help you rack up tax-deferred investment gains for later. For example, in the 2014 tax year, you could feasibly contribute as much as $17,500 in deferred salary ($23,000 if you were 50 or older) plus another 25% of your net self-employment earnings after deducting one-half of self-employment tax and contributions for yourself, up to a maximum of $52,000 total for both contribution categories, with a self-employed 401K, for example. Contribution limits vary by plan type and the IRS adjusts the maximums annually. Just this year, for example, the solo 401(k) contribution limit increased to $53,000.

Your RMD’s

If you’re turning 70½ this year, you have to take your 2015 required minimum distribution (or RMD) by April 1 of 2016, and you also have to take your 2016 RMD by the end of the year, Dec. 31, 2016. That means you could be taking two RMDs in 2016, which might result in a higher tax bill. It is best to consult with a tax planning professional to determine how best to approach your RMD this tax season.

If you’re 70½ or older this year, you must take a 2015 required minimum distribution by Dec. 31, 2015. Remember, there are significant penalties for not taking your RMD during the correct timeframe, including potentially having the undistributed portion taxed at 50%.