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Tax Time Is All About Saving Money
For the past two issues, we’ve
detailed tips on filing your taxes. Here are four tax-saving
tips regarding your portfolio.
BY AL ZDENEK
Before you know it, long lines will be
forming outside the post office on the evening of April
15. Individuals will be rushing to file their taxes. Many
have to pay big bucks to Uncle Sam, but you don’t
have to be one of them. There are numerous steps you can
take to save—or reclaim (e.g., Canadian tax withholdings,
see March 23 PF)—money. Below, we ask you four questions
regarding your portfolio and taxes and tell you how to take
action and save some green.
1) Are you forgetting to periodically
re-balance your portfolio allocations?
This could result in greater downside risk exposure than
you intended, or in the portfolio not producing the investment
return you need.
Take Action
Once you have determined the optimal asset allocation in
your portfolio, review the portfolio at least annually to
re-allocate your portfolio back to the original allocation.
This will force you to take gains where it is prudent and
place investable cash in those parts of the portfolio that
may produce gains in the future.
At this time, also review your original
portfolio allocation to ensure this allocation will produce
the long-term investment return you need to live the lifestyle
you wish for the rest of your life.
2) Are withdrawals taken from
tax-deferred accounts increasing the amount of income taxes
you pay?
Take Action
Structure your portfolio such that taxable accounts are
first being used to meet your income needs, possibly with
some withdrawals from tax deferred accounts to lessen the
amount of income taxes you pay.
Structure your portfolio so that some
of your fixed income securities generate tax-free interest.
Review this at least annually with your
personal financial planner.
3) Are you remembering to deduct
portfolio management and administrative fee expenses on
your 1040?
Most people allow management and administrative fees to
be deducted from their IRAs and pensions. If fees are deducted
this way, they can’t be used as a tax deduction on
your personal or business return (if your business has a
pension plan).
While saving can be modest when your IRA
or pension is small or when you use mutual funds, savings
can be quite substantial if the account is a good size.
Take Action
Have your annual management fees charged to you directly.
Then you can deduct the fee. For instance, if you have a
$250,000 IRA and are charged an annual management fee of
1 percent of the account value ($2,500), you may be able
to save $1,000 on your tax return (40 percent X $2,500)
if you have your management company charge you directly.
Obviously, the larger your IRA or pension
plan (if self-employed) account, the larger your savings.
For example, if you’re charged $20,000 in administrative
fees for your IRA and pension plan accounts, you’ll
be able to save $8,000 per year by having the management
companies charge you directly.
4) Are you reducing your income
tax burden by investing in the right type of portfolio account?
The type of accounts into which you invest your different
portfolio allocations can either decrease or increase your
income tax burden, especially with the change in income
tax laws the past few years. It’s important to know
which is which.
Take Action
Understand the implications and consequences of allocating
investment dollars into taxable and tax-deferred accounts.
You’ll be a smarter investor and reduce your tax burden.
Let’s say you have $1 million to
invest and have a targeted rate of return of 8.5 percent
per year (or $85,000 total yield per year). Assume that
you have half the money in a taxable account and half in
a tax-deferred account.
Further, you decided to have a portfolio allocation of 50
percent bonds and 50 percent stocks. Assuming the bonds
earn a seven percent current yield (and there are no capital
gains) and the stocks earn no dividends but 10 percent capital
gains, into which account would you place the bonds and
into which would you place the stocks for the best tax consequences?
By placing the bonds in the taxable account
and the stocks in the tax-deferred account, your tax on
the $85,000 would be $14,000 [40 percent X (7 percent X
$500,000)]. There would be no tax on the capital gains in
the tax-deferred account.
However, if you placed the bonds in the
tax-deferred account and the stocks in the taxable account,
your tax on the $85,000 would be $9,000 [15 percent X (10
percent x $500,000)]. Of course, the tax on the bonds in
the tax-deferred account would be zero. Therefore, you could
save $5,000 per year in income taxes—or add another
0.5 percent yield to your portfolio ($5,000/$1 million).
Over a 30-year period of time, this could add an additional
$692,000 to your wealth ($5,000 X 8.5 percent X 30 years)
without requiring any additional work or man-hours.
These tax tips, along with those we’ve
discussed in the past two issues, will help you save money
and make tax time more smooth and painless.
Al Zdenek, CPA, PFS,
is president and founder of Zdenek Financial Planning. The
firm has offices in New York City and Flemington, NJ (www.zdenek.com).
reprinted with permission from
Personal Finance newsletter www.pfnewsletter.com
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