Why Tax Planning Should Be a Key Component of Investing

Considering the tax consequences of your investments should be a key component of structuring your investment portfolio and investment strategy. Long term capital gains rates are half of ordinary income rates (20% versus 39.6%) for high income taxpayers. For those with married couples with incomes above $250,000 and individuals with incomes above $200,000, there is an additional “net investment income” tax of 3.8%, above the regular tax rates.

Here are some ways that good planning regarding your investments can save you taxes.

Where you put certain investments: Investments such as REITS (real estate investment trusts) and TIPS (Treasury Inflation Protected Securities) generate ordinary income. While REITS pay dividends, they are not treated like regular corporate dividends. They are specifically taxed at ordinary rates, which can be as high as 39.6%.

For investments such as these, we would try to place these investments into a tax deferred account, such as an IRA or a 401(k) plan. By doing this, you can get the benefit of the investment, while avoiding any tax until you withdraw the funds.

Use tax managed mutual funds: For stock investments, we recommend using mutual funds that make a concerted effort to reduce the tax impact of their investment holdings. A tax managed mutual fund manager will make, or delay, trades to reduce or minimize the taxable distributions of the fund. They will make trades specifically to recognize losses, which they can use to offset other trades made at a gain. They may also delay recognizing gains, to reduce taxable distributions.

For clients with taxable investment accounts, we strive to utilize these “tax managed” funds whenever possible. The objective of these funds is to deliver optimal returns, while at the same time being very conscious of the tax ramifications of their trading activity. Investors should review whether the mutual funds they own, or the money managers they use, focus on tax management for their taxable investment accounts.

Be aware of tax loss opportunities: Throughout the year, and not just in December, we monitor client accounts to determine if there are trading opportunities to recognize capital losses. Monitoring and being conscious of tax loss opportunities on a year-round basis is important, as an opportunity to sell an investment at a loss may be available early in the year, but if the investment recovers later in the year, the loss selling opportunity will have been missed.

This strategy is dependent on when an investment is purchased and subsequent market activities, but this is an important value-added service that an advisor should provide. The opportunities may not exist every year, but when they do, they can be important.

Monitor mutual funds for taxable distributions: As most mutual funds make their large taxable distributions in the latter part of the year, we closely monitor the projected distributions of the funds that we recommend. Depending on when an investment was originally purchased and the current value of the holding, we evaluate the impact of the projected distribution. If it makes sense and will save the client taxes, there are sometimes opportunities to sell more recent purchases of a fund prior to its taxable distribution.

Summary: An important benefit of our investment strategy and monitoring of our clients’ accounts are to minimize the tax impact of their investments. The above are examples of some of the strategies we utilize.

The key is that as an advisor, we actively take steps to minimize or reduce the tax impact of your investments, without sacrificing investment performance.

Are you, your advisor or a money manager used by your advisor taking steps to reduce the tax impact of your investments?


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