Most advisors were holding their breath at the end of 2010 because we did not have a clue how the tax laws were going to change for the years going forward. This made it difficult to make decisions on tax harvesting-selling stocks or funds to take advantage of gains and/or losses. This was mostly affecting the decision to take gains in 2010 if the maximum capital gain rate was going to be increased in 2011. Another area of apprehension was whether to convert traditional individual retirement accounts to Roth IRA’s affecting the choice to pay the taxes all on the 2010 tax return, or split it 50/50 between tax years 2011 and 2012. As you can imagine, it would have been valuable for individuals, tax planners, and financial advisors to have the answers to these questions well in advance of December.
As the saying goes “all good things take time”. Our patience was rewarded with a two year extension of the current tax laws and rates. This will give clients and their advisors more time to plan the best course of action for their portfolios and estate plans in preparation of possible higher tax liabilities in 2013.
One area where there will be an increase in taxes is a 3.8% surtax to higher-income taxpayers on investment income starting in 2013 which was part of the new health care bill. This surtax can be minimized in some cases by repositioning assets in a portfolio for tax-deferred, tax-free, or tax-sheltered growth and income. Tax-deferred income can be derived from investments in fixed or variable annuities, cash value or variable universal life insurance, before and after tax IRA contributions and making maximum contributions to corporate retirement plans. Tax-free income can be generated from investments in municipal bonds and municipal bond funds. Tax-sheltered income comes from investments in various types of investment trusts such as real estate investment trusts, gas and oil investment trusts and assisted living retirement trusts to name a few. Section 529 college plans and health savings plans (HSA’s) will also help reduce the impact of the new tax. Some of these plans have maximum contributions limits based on age such as the retirement plans, 529 plans, and HSA’s.
Another way to lessen the impact of higher taxes in 2013 and longer is to gift away those assets whose income will land on your tax return. This will also lessen the blow of the estate tax liability at your death. The annual gift exclusion is still $13,000 per year per person but you can gift this amount to as many people as you like such as children, children’s spouses, grandchildren and even friends. The unified estate and gift tax credit amount was increased for 2011 to $5 million per spouse or $10 million per couple. The generation-skipping transfer tax exclusion was also increased to $5 million.
Repositioning assets from high dividend paying securities to tax-favored securities such as exchange-traded funds (ETF’s) and traditional mutual funds that pay little or no dividends will lower the income on your tax return. A more creative option would be to put growth oriented stocks and funds into a Roth IRA which does not require mandatory distributions, income stocks and funds into variable annuities or traditional IRA’s (withdrawals are taxed as ordinary income not investment income), and keeping the non-IRA/annuity assets in tax-favored securities. Of course, depending on your situation, some combination of the above may help lower your taxes.
There are so many ways that the government allows you to save taxes. If you don’t use them, they don’t care. I am sure if you saved 35% of any amount of income, you would be thrilled. As you can imagine from just the few suggestions I have given you, there are many ways you can make changes in your portfolio without giving up growth or income. One way to maximize this is to work with professionals who are versed in all areas of investment and tax planning as they will most likely be able to prepare you for upcoming changes before they happen. Finding professionals that think creatively is valuable to helping you increase your assets and reduce your taxes. Keep in mind to look for help from advisors who are sensitive to the fact that, although we have a two year extension of current tax laws, time goes fast and changes probably shouldn’t be made all at once. Again, without trying to be redundant, ALL GOOD THINGS TAKE TIME.
Robin S. Davis is a Certified Financial Planner™, a member of the Financial Planning Association, and is the owner of Davis Wealth Management Group, Inc., in Stuart, Florida. She has been advising retirees since 1984 and has held over 500 public seminars on financial issues. She is the author of the book Who's Sitting On Your Nest Egg? Why You Need a Financial Advisor and Ten Easy Tests for Finding the Best One. Davis expresses the importance of utilizing a competent financial advisor. For more information, please call (800) 896-5422 or (772) 463-4441, visit www.daviswealth.com, or email: firstname.lastname@example.org.
Davis Wealth Management Group, an independent firm with securities offered through Summit Brokerage Services, Inc. Member FINRA & SIPC, and advisory services offered through Summit Financial Group, Inc., a registered investment advisor.