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Making Taxes More Convenient

In the book Gone with the Wind by Margaret Mitchell, Scarlett O'Hara complains, "Death, taxes and childbirth! There's never any convenient time for any of them." Surprisingly insightful, Scarlett declares what we all feel every year as April 15 marches closer. It's not even December yet, though, so we can relax, right? Actually, tax planning can happen all year long and it's always a good idea to take one final look at your tax picture with an investment advisor before the end of the year.

I can help you determine whether you are paying more in taxes than necessary by meeting with you for a no-cost tax and investment strategy session. Here are some of the ways taxes can impact your investment portfolio which we would discuss in that session.

Capital Gains: When you sell an investment at a profit in a taxable account, you will owe taxes on that profit. And, if you owned the investment for less than one year, those taxes can be significantly higher - up to 40% with combined Federal and State rates. Capital gains taxes are also paid on some mutual fund distributions even when you haven't sold any shares because taxable gains are passed to you when the fund makes year-end distributions. There are a few things you can still do before year-end to mitigate this impact:
1. The first item is simple - do less. If you can structure your portfolio to minimize short-term trading and to hold investments for longer than one year you will pay the more favorable long-term capital gains rate.
2. Second, we can look to harvest tax losses. In a diversified portfolio, you will usually have at least one type of investment that has not done well recently. By selling this investment, the loss can be used to offset gains in other parts of your portfolio. In addition, up to $3,000 of capital losses can be used to offset your ordinary income (for a married couple).
3. Third, consider moving out of mutual funds into lower-cost and more tax-efficient exchange traded funds (ETFs) in your taxable accounts prior to the year-end capital gains distributions. You need to be careful here as you don't want to recognize further capital gains by selling funds where you will recognize capital gains.
Dividends and other income: You will pay taxes on interest, dividends, and any rental or other income. Qualified dividends will be taxed at lower rates. Interest on bonds and most other investment income will be taxed at higher ordinary income tax rates. One exception is municipal bonds. Municipal bonds pay lower rates, but are generally exempt from Federal taxes (and State taxes if you live in the state where the bond was issued). Careful analysis is needed to determine if a lower-yielding municipal bond will earn you more in after-tax money than a traditional corporate bond.
Retirement Accounts: You should take advantage of any retirement account offered through your employer, particularly if they offer matching funds. The great thing about traditional IRAs and 401(k)s is that they reduce your taxable income and grow tax-deferred. Roth IRAs are also important investments that offer tax-deferred growth and tax-free distributions upon retirement.
1. One item to carefully analyze is whether it makes sense to do a Roth conversion before year-end. You will have to pay taxes on the distribution from your Traditional IRA, but once the money is converted, it grows tax free and your distributions from the Roth are tax-free as well.
2. Another key advantage to having more assets in your Roth IRA is that required minimum distributions (RMDs) do not have to be taken from your Roth as they do from your Traditional IRA when you turn 70 ½. Oftentimes it can reduce your overall taxes to do small conversions each year before you start your RMDs to make your eventual RMDs smaller and keep you in a lower tax bracket in retirement.
Tax-favored Accounts: Health savings accounts (HSAs) and 529 plans (saving for educational expenses) are other ways to save tax-free. There are guidelines and limits, but they just may work for you.

These are just a few ways you can actively manage your portfolio to reduce the impact of taxes. A tax and investment strategy session with me involves reviewing your overall financial situation, including your investment portfolio and making changes when possible to increase your after-tax returns. While there is never a "convenient time" for taxes, you can minimize your tax bill through careful analysis and planning.

If you would like to schedule a no-cost tax and investment strategy session,
email me at mhaertzen@wtwealthmanagement.com or call (520) 204-1058.

Sincerely,

Matt Haertzen

Matthew J. Haertzen

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Making Taxes More Convenient

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