Taxes are the largest drag on investment returns - greater than inflation, transaction costs, or management fees. Studies have shown that taxes can reduce returns by as much as 1 to 3 percentage points. Recent tax increases should increase these percentages significantly, making it more important than ever to manage tax drag on your investment returns.
Today we are going to talk about how you can lighten that tax drag, and just maybe avoid taxes altogether on some things.
When it comes to investing, most people do not put much thought into the consequences of a buy or sell. Here at Piershale Financial Group we prefer to know the consequences of a transaction BEFORE the transaction takes place. Especially when it
It begins with knowing your tax bracket. Once you understand what your tax bracket is, then you can begin looking for opportunities to address tax drag.
For example, say we have a couple in their early 60's about to retire. They each are high wage earners filing a joint return and are in the 33% bracket. They also have 401k and 403b plans with large balances.
Because they are about to retire, after they leave their jobs their earned income will more than likely take a large drop. That’s typical when you retire. This will more than likely place them in a lower income tax bracket. If they end up in the 15% tax bracket even for just a couple of years, they may have some opportunities they can take
Let’s say hypothetically they own a stock not held in an IRA that has a large long term capital gain; it can be sold with no tax up to the top of their 15% bracket. This is because of the zero percent capital gains rate when you are in the 15% marginal tax bracket. See how that works? Let’s look at another example. How about conversion possibilities for a Roth IRA? Roth IRAs are tax free. Remember, our couple has large balances in their 401k and 403b plans that have been tax deferred over the years. Because they will more than likely be in a lower bracket, they could consider Roth conversions with these plan balances. They could do enough in conversions to get them to the top of their current tax bracket and stop. Wait until next year and repeat. They could continue like this as long as they are in a lower bracket.
A Roth has many benefits, they can be tax free, they're not subject to required minimum distributions (RMDs) like traditional IRAs at age 70 1/2, and they do not trigger the 3.8% surtax on investment income, and they pass to beneficiaries’ tax free! There’s even more benefits of a Roth, this is just a partial list!
The point we are trying to make is there are ways to plan to help you lower your income taxes or avoid triggering other taxes. But how will you know unless someone tells you? That’s our job, please come in and see us!
The content is developed from sources believed to be providing accurate information. The information in this material is not intended as tax or legal advice. It may not be used for the purpose of avoiding any federal tax penalties. Please consult legal or tax professionals for specific information regarding your individual situation. The opinions expressed and material provided are for general information, and should not be considered a solicitation for the purchase or sale of any security.