Insights & News

July 2015
Tax Planning

Three Ways FAI Reduces Your Taxes With Portfolio Management

By Lyn Dippel, President & CEO

Everyone likes making money on their investments, but most people don’t like having to pay taxes on those returns. Interestingly, only certain portions of your investment return are subject to taxes in any given year. Interest and dividends are taxable in the year made (unless they are earned in a tax-deferred account such as an IRA or 401(k)). Capital gains are only taxed when the investment is sold. This creates an opportunity for FAI to strategically manage your investment portfolio in a way that minimizes your tax bill each year.

Since interest and dividends are taxed at your highest personal income tax rate, they are typically taxed at a higher rate than capital gains which are usually taxed at 20%. Many people have both after-tax accounts (individual accounts, joint accounts, trust accounts, etc.) as well at tax deferred accounts. Therefore, the first tax management strategy we use is to strategically place higher income and dividend earning securities in tax-deferred accounts and to place growth and capital gains items in after-tax accounts. Since all funds withdrawn from tax deferred accounts regardless of the source of the return are taxed at your highest marginal income tax rate (not the capital gains rate), we want to make sure you don’t overpay. Strategic placement of securities in your accounts is key.

Second, because we often use individual stocks as opposed to mutual funds or ETFs for the equity part of your portfolio, we are able to actively manage the realization of gains. If you own a mutual fund you may have noticed that it will typically distribute capital gains to the fund holders in December. This does not increase your return, because the value of the funds will fall in direct proportion to the amount that was distributed, but it will increase your tax bill. Last year was a dramatic example of this; many fund holders were surprised at their tax bills due to mutual fund gains distributions. Stockholders have control over the distributions and can realize them strategically as we do for our clients.

Third, sometime in the fourth quarter we estimate the amount of realized (taxable) gains your portfolio will generate for the year. We then look for any positions that have a temporary loss. Often we can sell a position for a loss and replace it with a similar position which then provides a tax loss to offset the taxable gain without sacrificing any actual return. If there isn’t a similar security to purchase as a replacement, we can wait 31 days and repurchase the exact same security. We will typically do this only if we will recognize a substantial tax savings and if it is a stable asset that we don’t expect to increase significantly in value in 31 days.

In these three ways alone, we are usually able to save you tens of thousands of dollars in taxes each year. There are other small things we can do such as purchasing appropriate municipal bonds if the investment rationale is also sound. However, the strategies discussed above are by far the biggest tax savings strategies and are NOT available to investors who use only passive investing strategies, index or asset allocation funds. It is one of the ways FAI adds value to your bottom line that can be measured in real dollars. After all, it is only what is left over after taxes that ends up in your pocket and can be used for your goals.

Please remember that past performance may not be indicative of future results. Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment, investment strategy, or product (including the investments and/or investment strategies recommended or undertaken by FAI Wealth Management), or any non-investment related content, made reference to directly or indirectly in this blog will be profitable, equal any corresponding indicated historical performance level(s), be suitable for your portfolio or individual situation, or prove successful. Due to various factors, including changing market conditions and/or applicable laws, the content may no longer be reflective of current opinions or positions. Moreover, you should not assume that any discussion or information contained in this blog serves as the receipt of, or as a substitute for, personalized investment advice from FAI Wealth Management. To the extent that a reader has any questions regarding the applicability of any specific issue discussed above to his/her individual situation, he/she is encouraged to consult with the professional advisor of his/her choosing. FAI Wealth Management is neither a law firm nor a certified public accounting firm and no portion of the blog content should be construed as legal or accounting advice. A copy of FAI Wealth Management's current written disclosure statement discussing our advisory services and fees is available for review upon request.

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