Recently we had a thrilling discussion about capital gains tax versus ordinary income tax in taxable investment accounts. I know, you'd probably rather watch paint dry. But understanding this stuff is important if you want to avoid handing over too much of your money to Uncle Sam.
Disclaimer: Anytime we begin to talk about tax stuff, we are always quick to remind you of a few things:
These thoughts are meant as a compliment to your common sense, not a substitute for it.
We are not tax professionals, and most of our readers are not either. So before you run off and take this piece as a personalized prescription, which it is not, do yourself a favor and run these ideas by your own tax professional.
There are general thoughts, not specific recommendations. It is impossible (and imprudent) to attempt to give personalized recommendations to a wide variety of readers.
Everyone clear on the rules? Good. Let’s dive back in.
Spoiler alert: the main advantage of understanding this is to pay less in unnecessary taxes. We believe everyone should “render to Caesar the things that are Caesars”, but we typically get no brownie points for rendering more.
Here's the deal: If you hold an investment in a taxable account for less than a year and sell it at a gain, good for you! You get the wonderful pleasure of paying ordinary income tax rates on this gain. And guess what? If you are like our typical clients, you are in one of the highest income tax brackets out there. At the time of this writing, the highest federal bracket is 37%, to say nothing of state or local income taxes as they may apply.
But hang on a minute. Let's say you had a similar investment in that same taxable account, but you're patient enough to hold on to it for a year or more before you sell it. This is where things get a little bit more interesting. You will be taxed at the much hyped capital gains tax rates. And guess what? These rates are often lower than your ordinary income tax rate.
I recently had someone do the math, and the difference that they might pay in taxes at ordinary income rates versus capital gains rates we're on pace to save them anywhere from 12 to 17% in taxes. Yes, you read that right.
And this is just one way that we help clients avoid unnecessary tax. Other ideas include strategic charitable gifting, wise use of qualified accounts (IRAs, 401(k)s, etc.), tax loss harvesting (another nail biter of a topic, just you wait) and using the comprehensive financial plan to see where there are gaps that we can fill. But this is a great tool that we have used to help a few clients reduce taxes.
Listen, investments are going to earn what investments are going to earn. But if you are able to move the needle on your taxable income by a little bit of strategy, it might be worth considering.
Any opinions are those of Tim Weddle, Financial Advisor, and not necessarily those of Raymond James. Any information is not a complete summary or statement of all available data necessary for making a decision and does not constitute a recommendation. Past performance may not be indicative of future results. Investing involves risk and you may incur a profit or loss regardless of the strategy selected. Contributions to a Roth IRA are never tax deductible, but if certain conditions are met, distributions will be completely income tax free. The cost and availability of life insurance depend on factors such as age, health and the type and amount of insurance purchased. As with most financial decisions, there are expenses associated with the purchase of life insurance. Policies commonly have mortality and expense charges. In addition, if a policy is surrendered prematurely, there may be surrender charges and income tax implications. Guarantees are based on the claims paying ability of the insurance company. Prior to making an investment decision, please consult with your financial advisor about your individual situation. Please also add one more disclosure: While we are familiar with the tax provisions of the issues presented herein, as Financial Advisors of RJFS, we are not qualified to render advice on tax or legal matters. You should discuss tax or legal matters with the appropriate professional.