Are You Taking Taxes Into Account When Saving And Investing?

How many of us save and invest with an eye on tax implications? Due to the complexities of both investing and U.S. tax laws, many investors do not understand how to manage their portfolio to minimize their tax burden. The more an investment relies on income rather than a change in its price to generate a return, the less tax-efficient it will be.¹

In the opening quarter of 2014, Russell polled financial services professionals and asked them how many of their clients had inquired about tax-sensitive investment strategies. Just 35% of the polled financial professionals reported clients wanting information about them, and just 18% said their clients proactively wanted to discuss the matter, even though , 75% of respondents said that they made tax-managed investments available to their clients.²

When is the ideal time to address tax matters? While year-end can prompt many investors to think about tax issues, sometimes your financial situation or sheer logistics get in the way. It is better to think about these things in July or January, or simply year-round. With a wider time frame to prepare, you may be able to increase year-end charitable donations, or put together a gift of appreciated securities, or make that extra retirement plan contribution. Sudden changes to tax law that present opportunities or unwelcome surprises may often be passed through at the eleventh hour, but your ability to respond to these changes may be improved if you keep tax issues on your radar year round.

Consider taxes as you contribute to your retirement accounts. If you contribute to a qualified retirement plan at work, you can lower your taxable income (and your yearly tax liability). Why? Those contributions are made with pre-tax dollars. In 2017, you can contribute up to $18,000 to a 401(k) or 403(b) account or the federal government’s Thrift Savings Plan. If you are 50 or older this year, you can put in up to $24,000 into these accounts. The same is true for most 457 plans. This can reduce your taxable income and lower your tax bill.^3,5

Think about where you want to live when you retire. Certain states have high personal income tax rates affecting wealthy households, and others don’t levy state income tax at all. If you are wealthy and want to retire in a state with higher rates, a Roth IRA may start to look pretty good versus a traditional IRA. Withdrawals from a Roth IRA aren’t taxed (assuming the Roth IRA owner follows IRS rules), because contributions to a Roth are made with after-tax dollars. Distributions you take from a traditional IRA in retirement will be taxed.³

What capital gains tax rate will you face on a particular investment? In 2013, the long-term capital gains tax rate became 20% for high earners, up from 15%. On top of that, the Affordable Care Act Surtax of 3.8% effectively took the long-term capital gains tax rate to 23.8% for investors earning more than $200,000.^3,4

Greater capital gains taxes can actually be levied in some cases. Take the case of real estate depreciation. If you sell real property that you have depreciated, part of your gain will be taxed at 25%. The long-term capital gains tax rate for collectibles is 28%. Own any qualified small business stock? If you have owned it for over five years, you typically can exclude 50% of any gains from income, but the other 50% will be taxed at 28%. Lastly, if you sell an asset you’ve held for less than a year, the money you realize from that sale will be taxed at the short-term rate (i.e., regular income), which could be as high as 39.6%.^3,4

Are you deducting all you can? The mortgage interest deduction is not always noticed by taxpayers. Prior to 2018, if a home loan exceeded $1.1 million, interest above that amount would not qualify for a deduction. That changed with The Tax Cuts and Jobs Act for 2018 which limits deductions for acquisition indebtedness - your mortgage used to buy, build or improve your home - of $750,000 ($375,000 for married taxpayers filing separately). For mortgages taken out before December 15, 2017, the limit is $1,000,000 ($500,000 for married taxpayers filing separately). With increases in the standard deduction and the elimination of many itemized deductions like home equity loan interest, moving expenses, casualty and theft losses, unreimbursed employee expenses, subsidized employee parking and transit, tax preparation fees, and more from 2018 through 2025, some taxpayers may see less need to itemize.⁶

A tax-sensitive investing approach is always specific to the individual. Therefore, any strategy needs to start with an in-depth discussion with your tax or financial professional.

1 - investopedia.com/articles/stocks/11/intro-tax-efficient-investing.asp

2 - russell.com/us/newsroom/press-releases/2014/russell-survey-advisors-say-tax-aware-investment-strategies-not-top-of-mind/

3 - foxbusiness.com/personal-finance/2014/08/07/investments-and-tax-planning-go-hand-in-hand/

4 - bankrate.com/finance/money-guides/capital-gains-tax-rates-1.aspx

5 - irs.gov/uac/newsroom/irs-announces-2017-pension-plan-limitations-401k-contribution-limit-remains-unchanged-at-18000-for-2017

6 - forbes.com/sites/kellyphillipserb/2017/12/20/what-your-itemized-deductions-on-schedule-a-will-look-like-after-tax-reform