The content contained in this article should not be construed as tax advice. Please consult your tax professional.
The thought of reducing taxes can bring a smile to anyone’s face. To help your filing go smoothly, you should familiarize yourself with the potential tax benefits during the year. Don’t wait until you file your taxes or receive your income tax returns—by then it may be too late.
Investing is a great way to grow your wealth and savings, but realizing any investment gains in taxable accounts often means paying taxes. The two categories of gains—short-term and long-term gains—are taxed differently: short-term capital gains are taxed at your ordinary income tax rate, while long-term capital gains rates are generally lower. But with a little planning, you can manage and potentially lower your tax bill. Consider the following four tax benefits in your planning that may lead to potential tax savings.
Mutual fund investors may receive an unexpected tax bill. Whenever a fund sells a position at a profit or reinvests dividends, the resulting capital gains or dividends are distributed to all shareholders (in proportion to their holdings). It doesn’t matter how long you held the fund—you may have to pay tax on long or short-term gains and dividends for transactions you didn’t make, even in years when the fund shows a loss.
While mutual funds may have benefits for some investors, you should consider investing in individual stocks if you’re looking for more flexibility and control. By investing in underlying securities rather than mutual funds, you get choose which securities to sell and whether to take a short-term gains, short-term losses, long-term gains or long-term losses.
It is great to have investment gains—even in taxable (non-retirement) accounts. But realizing any capital gain—when you sell an asset for more than its cost basis—could mean paying capital gains tax. There are some tax-loss selling strategies you may be able to utilize. In a taxable account, you may be able to offset some capital gains with capital losses by selling losing positions. We refer to this practice as “tax-loss harvesting.” Just be aware of the “wash sale rule” against buying the same or substantially identical security within 30 days after selling a security. The wash sale rule seeks to prevent investors from incurring losses and repurchasing securities immediately after selling them. If you end up incurring a wash sale, you may not be able to use the tax loss to offset your capital gains.
This doesn’t mean you should sell all your losing stocks as an investment strategy. Losses are bound to happen, and losses alone shouldn’t necessarily change your outlook for a stock. Tax-loss selling to offset your capital gains, however, can be a viable way to help mitigate your tax bill.
You may have saved some money in a tax-deferred account, such as a traditional 401(k) or individual retirement account (IRA). Hitting the annual contribution limits for such accounts may reduce your current tax burden and save more for the future. However, it’s important to note that the more money you save in tax-deferred accounts, the more you may need to rely on those accounts for income in the future. When you withdraw money from tax-deferred accounts, you will pay ordinary income taxes on that income, which may be higher than the taxes you would pay on long-term capital gains.
An alternative to a tax-deferred account is a tax-exempt account, such as a Roth IRA or a retirement plan with Roth contributions. In these accounts, you pay income taxes now, and when you withdraw the funds in the future, you normally will not owe income taxes on withdrawals. With tax-exempt accounts, one potential tax benefit is you won’t pay capital gains taxes on your investment gains. That means you won’t have to pay income taxes on your withdrawals or capital gains taxes on short-term capital gains, short-term losses, long-term capital gains or long-term losses.
The option that will benefit you most depends on your current tax rate and your potential tax rate in retirement, so it may be best to discuss your options with a tax adviser.
RMD is the minimum amount many retirees are required to withdraw annually from retirement accounts such as a 401(k) or traditional IRA.[i] The IRS installed this rule to ensure your assets are taxed someday, and if you don't act, you may have to pay penalties on whatever you didn't take. There are some exceptions like Roth IRAs, which generally don’t have RMDs.
Required minimum distributions normally begin after you turn 70 ½. The RMD amount is likely to vary based on your age and savings. And if you have multiple accounts, each one will have an RMD. You can combine the accounts for simplicity, but we recommend consulting your investment adviser and tax advisor if you plan to do so.
Tax planning has several parts and varies among investors, so consult your tax advisor. As you plan for the current tax year, you will need to consider the tax implications specific to you and your financial situation. Tax-loss harvesting strategies may be able to reduce your tax bill. Though Fisher Investments is not a tax advisor, we have helped thousands of investors perform regular tax-loss harvesting over the years. If you would like to learn more about tax-loss harvesting and how Fisher Investments may be able to help you, call and speak with one of our qualified representatives or download Your 2019 tax guide.
[i] Source: Internal Revenue Service, as of 2/28/2019. https://www.irs.gov/retirement-plans/retirement-plans-faqs-regarding-required-minimum-distributions.