Making Cents: Investors need to consider tax ramifications
John P. Napolitano, business columnist for Patriot Ledger.
After factoring in federal income and capital gains taxes, the alternative minimum tax, and potential state and local taxes, your investments’ returns in any given year may be reduced by 40 percent or more.
Here are five ways to potentially lower your tax bill.
Tax-deferred accounts include employer-sponsored retirement accounts such as traditional 401(k)s and 403(b) plans, individual retirement accounts (IRAs) and annuities. Investment earnings compound tax-deferred until withdrawal, typically in retirement.
Contributions to non-qualified annuities, Roth IRAs and Roth-style employer-sponsored savings plans, are not tax-deductible. Earnings that accumulate in Roth accounts can be withdrawn tax-free if you have had the account for at least five years and meet the requirements for a qualified distribution.
Withdrawals from these accounts prior to age 59½ may be subject to a 10 percent federal penalty.
Interest on U.S. government issues is subject to federal taxes but is exempt from state taxes. Municipal bond income is generally exempt from federal taxes, and municipal bonds issued in state may be free of state and local taxes as well.
Tax-managed or tax-efficient investment accounts are managed in ways that can help reduce their taxable distributions. Investment managers can potentially minimize portfolio turnover, invest in stocks that do not pay dividends and selectively sell stocks at a loss to counterbalance taxable gains elsewhere in the portfolio.
You may also be able to use losses within your investment portfolio to help offset realized gains. If your losses exceed your gains, you can offset up to $3,000 per year of the difference against ordinary income. Any remainder can be carried forward to offset capital gains or income in future years.
Maintain records of purchases, sales, distributions, and dividend reinvestments so that you can properly calculate how much you paid for the shares you own and choose the most preferential tax treatment for shares you sell. While federal laws now mandate that financial companies track and report your tax basis, there are still holdings in most portfolios that predate these laws, and you’ll need to do some digging.
This information is general in nature. Always consult a qualified tax adviser for information as to how taxes may affect your particular situation.
John P. Napolitano is CEO of U.S. Wealth Management in Braintree, Mass., and 2012 president of the Financial Planning Association of Massachusetts. He may be reached at email@example.com or on Facebook as JohnPNapolitano.