December is a great time of year to visit family, enjoy holiday meals, and streamline April’s tax bill. With a bit of knowledge, you can really boost the tax efficiency of your portfolio and even your gift giving, so this month I’d like to share a few simple tips for getting the most out of your investments come tax time.
Tip 1: Harvest Your Losses
If one part of your portfolio realized a significant gain this year, or if you’re facing an increase in other sources of income tax, you may want to offset those gains by taking a loss somewhere else. By selling a losing investment at a loss, you can offset some of the tax burden on the asset that gained. The benefit of this strategy is that you can buy into a similar mutual fund or stock at similarly depressed prices, so that your long-term strategy remains the same. Remember, however, that you cannot reinvest in the exact same mutual fund or stock until 30 days after the sale, but investing in another mutual fund with a similar strategy is fine.
Tip 2: Be Careful with New Investments
At this time of year, mutual funds begin announcing their capital gains. Even if, overall, the mutual fund has experienced losses over the year, certain positions may have been sold at a gain. These gains are reported annually to mutual fund holders, who are obligated to pay taxes on the gains they enjoyed throughout the year. The potential for capital gains is important to keep in mind when making a new investment. If a mutual fund is planning to distribute capital gains, wait until after the distribution is made before purchasing new shares. Otherwise, you may have to pay taxes on gains that your shares didn’t participate in.
Tip 3: Contribute to Your Retirement Plan
You have probably read this advice in several places, but it’s so important I have to include it here. Saving for retirement can not only help you reduce your tax bill now, it helps you to prepare for a comfortable future. So, if you have a 401(k), 403(b), Deductible IRA, Simple IRA, or SEP, remember that you can make contributions up until December 31 for the 2011 tax year.[i] Many plans also offer matching employer contributions, which is essentially an income bonus paid straight to your account. Thus, if you aren’t already, I recommend that you seriously consider saving enough to max out your employer matching contribution. It will help you both today, in reduced taxes, and tomorrow, when you’re ready to retire.
If you don’t have an employer 401(k), you can always contribute to an IRA account. In this case, you have until the tax filing deadline in April to make your contribution for 2011.[ii]
Tip 4: Strategize Your Charitable Giving
Instead of writing a check to your favorite charity this year, consider giving the gift of stocks or mutual funds. If you have holding which experienced long-term capital gains and you donate it to a charity instead of selling, you can deduct the full current value of the holding[iii], avoid paying taxes on the capital gains, and support your favorite charity. The charity won’t have to pay taxes on the profit when it sells the position, which is a win-win for both you and your cause.
If you do decide that you’d prefer to give cash, remember that checks postmarked in 2011 and credit card donations are immediately deductible, but pledges are not tax deductible until they are paid.[iv]
Tip 5: Reconsider the Gift of Stocks for Kids
If you’d like to get the gift of stocks, bonds, or mutual funds for a child in your life, keep in mind that investment income earned by children under 18 that exceeds $1,900 per year is taxed at the parent’s rate. This rule also applies to kids up to age 24 who are full-time students and whose own earnings don’t cover more than half of their expenses.[v]
Thus, if you’d like to give a gift to your child, grandchild, or other family member, consider either a cash gift, which is non-taxable up to $13,000. If you’re married, both you can your spouse can each give a gift of up to $13,000 tax free.[vi] For another option, consider giving the gift through an educational savings plan, such as a 529. While contributions to 529 plans aren’t tax-deductible, investments in these plans grow tax-free, and distributions for educational expenses are federally tax-free.[vii]
Tip 6: Remember to Take Your Mandatory Distributions
If you are over the age of 70.5 and retired, you must begin taking Required Minimum Distributions (RMDs) from your retirement accounts (if you haven’t yet retired and own less than 5 percent of the business sponsoring your retirement plan, you can wait). You are responsible for computing the correct amount to withdraw and taking the withdrawal every year (your advisor and or CPA should be able to help you with this ). Forgetting to do this can result in stiff penalties; namely, the amount that you fail to withdraw is taxed at 50 percent instead of your usual income tax rate.
Note that Roth IRA accounts are not subject to the same rules as other retirement accounts. For more information on planning your RMD, refer to the IRS website or speak to your financial advisor.[viii]
Keep an eye out for more tax tips coming soon!
[i] Internal Revenue Service, “Publication 525.”
[ii] Internal Revenue Service, “Publication 590.”
[iii] Internal Revenue Service, “Charitable Contributions,” page 11.
[iv] Internal Revenue Service, “Publication 526.”
[v] Internal Revenue Service, “What Parents Should Know About Their Child’s Investment Income.”
[vi] Internal Revenue Service, “Publication 950.”
[vii] Internal Revenue Service, “Tax Benefits for Education.” Page 54..
[viii] All information, Internal Revenue Service, “Retirement Plan FAQs Regarding Required Minimum Distributions.”
Written by Bradford Pine
Bradford Pine Wealth Group – New York City Financial Advisors
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