Balance Tax Goals with Investment Strategy

How much should taxes influence your investment strategy?

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Many investors don’t even consider income taxes until it comes time to finalize their tax return. By then, it is too late to do anything about them. Others obsess about taxes to the point they won’t sell an investment if it would generate capital gains tax. Both approaches are flawed.

Tax rates have increased significantly on investment income over the past few years. The new Medicare surtax adds an additional 3.8% rate on net investment income. Taxpayers will face a new tax bracket for upper income filers, which raises the tax on long-term capital gains from 15% to 20%. These are substantial increases, but focusing too much on taxes can cause an investor to lose sight of their investment strategy. At this point, the tail (income taxes) is wagging the dog (investment return).

There are a couple of simple rules to follow, which can help reduce income taxes without affecting your investment strategy:

  1. Pay attention to your holding period before selling an investment. A position must be held 12 months to qualify for long-term gains tax treatment. Short-term gains are taxed as ordinary income at rates from 10% to 39.6%. Long-term gains are taxed at 0% to 20% – a significant tax savings.
  2. Use tax-deferred accounts to hold less tax-friendly investments such as preferred stocks, taxable income funds, or high turnover stock funds that generate a lot of short-term capital gains. Stocks and stock mutual funds that you intend to hold long term, as well as tax-free municipal bonds should be held in taxable accounts.
  3. Avoid automatically reinvesting dividends and capital gains distributions in taxable accounts. In our opinion, rebalancing should be a part of everyone’s investment strategy. Dividend distributions are taxable whether the funds are reinvested or not. Use the distribution to help you rebalance by directing these funds to the part of portfolio currently under-weighted.

Will Your Money Last Through Retirement?

No one wants to run out of money. But without goals and a solid plan,
how can you know for sure whether you’re on the right track?

Will I be able to maintain my current lifestyle?

What will my monthly income be in retirement?

Can I protect my hard-earned savings and still
have the income I want?

Rodgers & Associates answers questions like these every day.

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2025 Lititz Pike, Lancaster, PA 17601
Phone: 717-560-3800, Toll-Free: 888-876-3437