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Due to the decline in the financial and real estate markets, some people may be worried they will outlive their savings. The following is a tip that can help make savings last longer.
Not all investment income is taxed at the same rate. It is very important to take this into account. It is generally accepted that investors should place their highly taxed assets (bonds or REIT's) in tax sheltered accounts and their low tax or tax efficient assets (mutual funds or stocks) in taxable accounts. Tax deferred accounts would include IRA's, 401k's or deferred variable annuities.
Holding tax efficient assets in tax deferred accounts can result in the following disadvantages:
— Long term gains taxed as ordinary income.
— Possibility of step up in basis for tax purposes is lost. When a person dies, the inherited assets are stepped up to present market value reducing taxes on the gain when eventually sold.
— For overseas holdings, foreign tax credits are lost. Taxes levied by foreign governments can be claimed on federal and state tax returns.
Not all investment income is taxed at the same rate. It is very important to take this into account. It is generally accepted that investors should place their highly taxed assets (bonds or REIT's) in tax sheltered accounts and their low tax or tax efficient assets (mutual funds or stocks) in taxable accounts. Tax deferred accounts would include IRA's, 401k's or deferred variable annuities.
Holding tax efficient assets in tax deferred accounts can result in the following disadvantages:
— Long term gains taxed as ordinary income.
— Possibility of step up in basis for tax purposes is lost. When a person dies, the inherited assets are stepped up to present market value reducing taxes on the gain when eventually sold.
— For overseas holdings, foreign tax credits are lost. Taxes levied by foreign governments can be claimed on federal and state tax returns.
— Potential for tax loss harvesting is lost. If you are unsure what this means, email me and I will send you the past article.
Lets take an example of a person who has one hundred and fifty thousand in accumulated savings and one hundred and fifty thousand in tax deferred accounts for a total of three hundred thousand dollars. The taxpayer is in a combined thirty five percent federal and state tax bracket. It is desired to keep half the assets in equities, and half in income producing investments like bonds and REIT's.
The equities have a dividend yield of two percent and the income producing assets of five percent. If they incorrectly had their incoming producing investments in a regular taxable account they would pay two thousand six hundred twenty five dollars in federal and state taxes on the income. If they instead held these assets in the tax deferred accounts and the equities in a taxable account, the taxes on the equities would be seven hundred and fifty dollars or a tax savings of almost nineteen hundred dollars.
This increases the return on the portfolio by slightly more than one half of a percent. Email me at gogettom@hotmail.com if you would like details on the math.
Lets take an example of a person who has one hundred and fifty thousand in accumulated savings and one hundred and fifty thousand in tax deferred accounts for a total of three hundred thousand dollars. The taxpayer is in a combined thirty five percent federal and state tax bracket. It is desired to keep half the assets in equities, and half in income producing investments like bonds and REIT's.
The equities have a dividend yield of two percent and the income producing assets of five percent. If they incorrectly had their incoming producing investments in a regular taxable account they would pay two thousand six hundred twenty five dollars in federal and state taxes on the income. If they instead held these assets in the tax deferred accounts and the equities in a taxable account, the taxes on the equities would be seven hundred and fifty dollars or a tax savings of almost nineteen hundred dollars.
This increases the return on the portfolio by slightly more than one half of a percent. Email me at gogettom@hotmail.com if you would like details on the math.
The savings come about because ordinary investment income which includes interest and non qualified dividends is taxed at higher rates that can be as high as thirty five percent for federal taxes plus state income tax, where qualified dividend income is taxed at a maximum rate of 15 percent federal, assuming the investor is not subject to AMT.
If the investor needs income to pay living expenses and is unable to tie up the money for future use in a tax deferred account, they could sell a small portion of their equity position to fund living expenses and keep the income producing assets in their tax deferred account.
Look for the next article which will discuss whether it is better to take withdrawals first from a tax deferred retirement accounts or from a non tax deferred account.
Tom Behlmer lives in Nevada City and is an investment advisor representative with Peak Investment Solutions, L.L.C. in Roseville. You can email questions to him at tbehlmer@peakis.net.
If the investor needs income to pay living expenses and is unable to tie up the money for future use in a tax deferred account, they could sell a small portion of their equity position to fund living expenses and keep the income producing assets in their tax deferred account.
Look for the next article which will discuss whether it is better to take withdrawals first from a tax deferred retirement accounts or from a non tax deferred account.
Tom Behlmer lives in Nevada City and is an investment advisor representative with Peak Investment Solutions, L.L.C. in Roseville. You can email questions to him at tbehlmer@peakis.net.
