From August 19, 2009
During periods of uncertain
returns, it becomes even more
important to consider other ways
to increase your portfolio's
value. One of those strategies
is to invest in a tax-efficient
manner.
Taxes can significantly reduce
your portfolio's value. Interest
income from taxable portfolios
and distributions from 401(k)
plans and individual retirement
accounts are taxed in the year
received, at ordinary income tax
rates of up to 35 percent. Taxes
are not paid on unrealized
capital gains in taxable
accounts. When the asset is sold
from a taxable account, however,
you must pay taxes on those
capital gains, at a maximum
long-term capital gains tax rate
of 15 percent. For 2008-2010,
that rate drops to zero
for certain individuals* in the
10 percent and 15 percent tax
brackets, for investments
held more than one year. Capital
gains on investments held for
one year or less are short-term
capital gains and are taxed at
ordinary income tax rates.
Using strategies that will defer
the payment of taxes for as long
as possible can make a
substantial difference in your
portfolio's ultimate size.
Consider the following
tax-efficient strategies:
-
Minimize portfolio turnover. Carefully evaluate your investment choices, selecting those you'll be comfortable owning for years. That way, you can let any realized capital gains grow for many years without paying taxes.
-
Place investments that generate ordinary income or that you want to trade frequently in your tax-deferred accounts. Since income and gains accumulated inside tax-deferred accounts aren't taxed until withdrawn, you defer paying taxes on that income. (Keep in mind that withdrawals may be subject to a 10 percent federal penalty if made prior to age 59 1/2.)
-
Analyze the tax consequences before rebalancing your portfolio. Portfolio rebalancing in a taxable account will trigger taxable gains and losses. You should generally avoid selling investments for reasons other than poor performance. You can bring your asset allocation back in line through other means. For instance, when adding investments to your portfolio, only purchase those that are underweighted in your portfolio. Reinvest interest, dividends, and capital gains in investments that are underweighted. Any withdrawals can be made from overweighted investments. Or rebalance through your tax-deferred accounts, which won't result in current tax liabilities.
-
Utilize losses to offset capital gains. Selling investments at a loss can offset capital gains for that year, reducing your total tax liability. Excess losses may be used to offset up to $3,000 of ordinary income and the unused portion may be carried forward indefinitely. If you still want to own that investment, you can purchase it 30 days before or after selling it. That way, you will not be subject to the wash sale rules, so your loss will be tax deductible.
*Note: Under current law, qualified taxpayers in the 10 percent and 15 percent tax brackets pay zero percent long-term capital gains tax in 2008 to 2010. However, certain full-time students under age 24 do not qualify for the zero percent rate under revised Kiddie Tax rules.
