Ready for a tax surprise?

Markets have been roaring in a historic bull run. The returns are welcomed by investors but fund managers may have begun re-positioning creating a jump in your taxes..

Why Should You Care?

It wouldn’t be the first time someone would ask this: “Okay, I don’t like taxes but isn’t it a good thing? It means I made money and I’m still up even after paying the taxes from my portfolio.” Well, that may be the case however studies have shown around a two-percent drag in returns per year due to taxes! What would you do with that extra money? Furthermore, would you feel the same if this were an extra 2% fee on your investment fees? Once you realize that you are creating an additional tax fee perhaps that thought would change.

Where to Look

Let’s start with the good news, your holdings in retirement accounts such as 401(k), IRA or Roth IRA accounts are protected from these taxes. So for those accounts you can skip digging too far unless you are considering to use some of the same holdings or strategies in non-retirement accounts. Take the time to review your non-retirement accounts that do not have a tax shelter (certain accounts such as annuity accounts will still provide shelter from taxes on capital gains and dividends). From there you can focus on actively managed positions in the account (mutual funds and managed accounts rather than ETFs or non-managed stock accounts). The reason why these positions are worth focusing on is because fund managers will sell positions that are up from the strong market for the purposes of rebalancing or replacing them as we move later into the markets cycle. If there are enough positions that have losses to offset these the impact may not be as large however, with such an extended bull market they can be potentially harder to find.

What is a Capital Gain (and why it matters)?

Capital gains are a tax event that takes place when an investment is sold for more than it had been purchased for (at a gain to your initial investment amount). They can be classified into long-term or short-term gains and have different tax treatments based off the long or short classification. Long term gains are classified when the investment has been held for twelve consecutive months or more, short-term gains are for any holdings of less than twelve months. A long-term gain will have a lesser tax impact than short-term gains (short-term gains are taxed at your income tax bracket). Capital gains can therefore be controlled (to an extent) by being mindful of the long/short status of your positions but also by using losses as write offs.

For more: Turn Back Your Clocks and Turn on Some Tax Savings Before 2019 is Gone

Visit: Tax Efficient Investing

What You Can Do

Thankfully, there are things that you can do to help address the cost of taxes on your portfolio. The first step is being aware, and luckily enough you are taking some of the first steps here educating yourself on the problem at hand. From here, you can start to review where your tax impacts are coming from: are they self-inflicted from sales that you place in your accounts? Are they from mutual funds in your accounts (if you aren’t selling and you still have capital gains in your taxes they are your most likely culprit, also look for what you may have thought of as an unusually high ‘dividend’ payment around year-end)? Are they from the management style in an account you have traded for you?

Once you know where they are coming from you are in a better place to take action. (See: Knowledge is Not Power, ACTION is). If your tax burden is self-inflicted, you can work on using your education and awareness to help make more tax-savvy decisions. If your mutual funds are the culprit you can look to use ETFs that do not have the same capital-gains payout rules and/or can be more passive in management to help dampen the tax bite (be aware this will add some additional oversight and action on your end as well). Finally, if your account is managed and your managers are the culprit you can talk to your advisor and/or manager to work on being more tax focused in the management approach.

Note: if any of these create additional time or responsibility needs that you are not comfortable taking on, set a FREE consultation call to discuss

 

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