The Danger Of Having No Strategy Or Ignoring Tax Efficient Investing Strategies
By Dr. Jeff Camarda EA, PhD Financial Planning, MSFS, CFA | REQUEST FREE CONSULTATION
This is without question the most fundamental mistake made by taxpayers and their tax advisors/preparers. For some reason, this industry is almost hopelessly re-active. Most clients and preparers don’t even look at the fact patterns until after the first of the year, when nearly all potential strategies are impotent, except the old “well, you could put some more into your IRA.”
The reason this is so important is the tax “game” has four quarters and they all end on December 31 st . After that, the score is mostly set in stone; it just is not visible until your preparer does the tax accounting.
In order to win the tax game, you need to play the game before it is over. Unlike the vast majority who don’t “plan” until after the end of the tax year, the smartest taxpayers and best tax advisors begin before the tax year begins, or at worst by summer of the tax year. Start planning much later than that, and even the best tax mind is a Monday morning quarterback.
As you accumulate wealth, taxes on investment returns become more and more important. Mutual funds with a lot of turnover are particularly tax inefficient since taxpayers are forced to pay tax on any gains or income the fund recognizes during the tax year, regardless of whether or not the investor themselves takes any income or recognized any gain. This has been widely viewed as unfair since implemented the late 1980s as part of tax reform, but widely ignored by taxpayers for decades, causing many to overpay. ETFs and single stocks are much more efficient in this regard. Deferred annuities are some of the most highly taxed products around—with really vicious LIFO and ordinary income tax treatment—but widely sold and swallowed as being tax shelters! Bond and CD income gets taxed at your highest bracket, but dividend income from stock sources enjoys a lower capital gains-type rate. Making stock changes at high market levels needlessly can exacerbate capital gains, and too many people still don’t do tax loss harvesting each year, which can save tens of thousands or more. All of the preceding has to do with non-qualified (non-IRA- like money), but there are lots of smart strategies for IRAs beyond the arbitrage discussed above. For instance, it is smart to put ordinary income rate (top marginal rate) assets like bonds in IRAs, but capital gains rate assets outside where they will enjoy the lower rate. Otherwise, in the worst cases, you can effectively pay about double the available tax rate! Worse yet, if the capital gains asset is one you might pass on at death, you may wind up paying the highest marginal rate instead of zero tax by way of the at death basis step up!
Dr. Jeff Camarda is a financial advisor located in Fleming Island & Ponte Vedra, FL. Dr. Jeff has over 33 years' experience working with local businesses and investors. More information about Dr. Jeff can be found at www.camarda.com.
This article was written by and presents the views of our contributing advisor, not the WiserAdvisor editorial staff.
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