This holiday season’s magic of making your investments work harder

What’s magic about this holiday season? As much as I wish that Santa with his naughty or nice list could blackmail major corporations to pay larger dividends, the power to boost your after-tax return on investments is up to you or your investment advisor.One way to maximize returns is with tax-loss harvesting. The idea is to harvest in Winter to create tax savings for the next Spring. And this year, as an exception, you may want to harvest the gains too. A big part of making your investments work harder for you is reducing the taxes on your returns, whether it’s a dividend or capital gain.Why take the gains now? Don’t you always want to defer income if at all possible? You don’t want to wait if you will have to pay more tax on the same gain. This could happen if Congress fails to extend the Bush era tax rates before year end. (Currently President Obama has come to agreement with the Republicans but the Democrats have not necessarily signed on.) If they fail to act, then you could pay 20% vs. the current rate of 5% for any gains recognized in 2011.What is tax loss harvesting? If you sell a holding for less than you paid, you will incur a loss. The losses can be accumulated to offset current and future capital gains as well as $3,000 of ordinary income per year. You read that right! If you incur a loss now you may be able to save a portion of the loss in tax savings.

Sounds good, but there are several key factors to consider:

  • This strategy only works for taxable accounts. It doesn’t work for your IRA or 401K plan.
  • If you bought the holding within 30 days before or after the sale, your loss would be disallowed as a wash sale.
  • The cost of sales and the transaction fees.
  • Your current tax bracket and any extraordinary income or deductions that may affect your tax bracket in 2010 or 2011. Maybe 20% of a lower tax bracket means less tax for you.

How to Get Tax Benefit without Changing the Asset Allocation Significantly

Let’s say you’re warming up to the idea of tax-loss harvesting or recognizing gains in 2010 vs. 2011, but you like your investment choices, even if they are currently not performing well. How do you implement the tax-loss harvest strategy without making a mess of the asset allocation of your current portfolio?Here are some tips for harvesting losses and keeping the same allocation, if not the same specific investment:

  • If the holding is a mutual fund you can purchase a like-kind replacement holding as long as it is from a different fund family.
  • You can wait at least 30 days and then buy back the holding if you sold it at a loss. Be aware that the market may go up and offset the benefit of the sale. If the market goes down, then “Bonus!”
  • You can replace the holding immediately if you are recognizing the gain.  The wash sale rules apply only to losses, and they do not apply to gains.

Sound simple so far? I hope so, but there’s nothing simple about taxes. If you have not already done so, I recommend checking in with your tax preparer to determine if tax-loss harvesting, or any other year tax-year tax planning strategies are appropriate for you. If you need help managing your investments I am available to develop a total strategy that considers your tax planning, your risk tolerance, and the degree to which you are adequately funded for your financial goals.  Please call me to set up a complimentary introductory meeting.