Tax Efficient Investing: 8 Last-Minute Money Savers to Help Investors Minimize Their Tax Burden
by Louis Basenese, Advisory Panelist, Investment U
Thursday, December 7, 2006: Issue #615
Editor's Note: Official tax season is several weeks away, but for our purposes, it's already here. While you can lower your tax burden by deducting mortgage interest, donating to charity and applying credits, the investment decisions you make right now play a key part, too. Today, Louis Basenese, Oxford Club Advisory Panelist and editor of the Oxford Hedge Trader, offers some simple - and some obscure - tax efficient investing tips to help investors maximize their gains before 2006 comes to a close. - Mark
The tax tail should never wag the investing dog. However, ignoring the tax consequences of your investment decisions could cost you dearly - or at least take a bite out of your above-average returns.
For many investors, the next 25 days could prove to be the most profitable of the entire year. And it has nothing to do with commodities, gold, or even the best growth stock on the planet.
The fact is, there are only two proven ways to fatten your portfolio. One is to make more money. The second is to keep the money you already have. That means holding the IRS "attack dogs" at bay by making sure your investing strategy is tax efficient.
After December 31st, there's little you can do to reduce your tax burden. But in the next few weeks, you have some profitable choices to make, and choosing wisely could mean big bucks down the line
8 Tax Efficient Investing Tips
1. Find Some Good Losers. If your capital gains are high, go ahead and take a few losses. Although you won't be able to brag about it to your neighbors, it will help offset your gains and, in the end, keep more money in your investment accounts. Be careful to avoid a "wash sale" by re-buying the same security within 30 days.
2. Max Out Your Retirement. Contribution limits to retirement plans jumped this year. For traditional 401(k) plans, it's up to $15,000. If you're over age 50, catch-up contributions also increased anywhere from $500 to $1000, depending on the plan type. Make sure you take full benefit from these tax-advantaged deposits.
3. Be Cautious About New Purchases. If you're thinking about buying a new mutual fund or making a sizeable addition to a current position, hold off. The later it gets in the year, the more likely you will pick up the capital-gains distributions. To be sure, check the distribution schedule - and if it's late in the year, wait until it passes before making your purchase or you will lose more money to taxes.
4. Be Selective About Any Partial Liquidation. If you find yourself selling a portion of an investment that you've accumulated over time, overcome the first-in, first-out (FIFO) convention by "specifying" to sell the more expensive shares first. Doing so limits your exposure, generates cash and minimizes your tax liability.
But be warned, this can be a tricky task and you'll need the cooperation of your broker. Your best bet is to follow these two steps: First, at the time of the sale, specify exactly to the broker the shares you want to sell. For instance, say "Sell 50 shares of XYZ from the lot purchased on March 12, 1996." Then get some backup by requesting a written confirmation of that specification.
5. Consider Your State's 529. The Pension Protection Act of 2006 ensured the favorable tax treatment of 529 plans extends beyond 2010. So, if the "sunset" issue kept you from setting aside money for your child's or grandchild's college education in earlier years, consider setting up an account this year. You can even choose to accelerate contributions and give up to five years' worth (up to $120,000 if it's a joint gift).
Although these contributions aren't deductible for federal income-tax purposes, going with your state's plan could earn you a deduction on state income taxes.
6. Get Away from the Ordinary. Dividends from certain investments (like bond mutual funds, money markets and REIT funds) are considered interest, and are taxed at ordinary income rates. If you're in line for a sizeable dividend, are thinking of liquidating anyway, and have held the position for more than a year, considering selling immediately before the payout.
Because the price of the investment will generally drop by payout amount, by selling early you get the higher sales price - and all of the proceeds will be taxed at the more favorable long-term capital gains rate.
7. Put Your Minimum Distributions to Work for Charity. Thanks to new laws, if you're over 70 1/2, you can give up to $100,000 directly from your IRA to a qualified charity. And you can do this with your required minimum distribution, if you're fortunate enough not to need the income.
A few caveats: Gifts must be from traditional or Roth IRAs, and the money must go directly to the charity, or you have to declare it as ordinary income.
8. Consider a Roth Conversion. Converting to a Roth IRA is an easy way to reduce minimum distribution requirements, as well as avoid taxes on any withdrawals. But keep in mind: You cannot convert unless your adjusted gross income (AGI) is $100,000 or less. (A new tax law will eliminate that threshold in 2010.)
Another reason to convert to a Roth is to pass money on to your heirs. They too will benefit from no mandatory withdrawals or income tax liabilities.
Remember that the tax efficient investing information above is to be used as a general guideline. We recommend you consult a qualified tax professional to determine how the various (and complex) IRS laws apply to your specific situation.
P.S. In the December 1st issue of The Communique, I was able to fit in nine more tax efficient savings that don't necessarily relate to investing, but could save you a lot of money - interest deductions, adoption credits, etc. If you're not yet a member and are interested, please learn more about The Oxford Club.
Today's Investment U Crib Sheet
- Proper tax planning is vital to building and protecting wealth over the long term That's why it's one of The Oxford Club's Four Pillars of Wealth. The other three? Using the Club's Asset Allocation Model, the Oxford "Safety Switch" and correct position sizing. Read How To Build Wealth: Achieve Your Financial Goals in the New Millennium Using Our Four Pillars of Wealth