The type of taxable income is a consideration when determining which type of assets to place in tax-deferred versus taxable accounts. Although we don't know what the future will bring for tax rates, in 2009 dividends and capital gains have lower rates than ordinary income. In some cases, dividends and capital gains may generate no taxable income. This benefit is lost when capital gains and dividends are realized in tax deferred accounts as they are taxed at ordinary income tax rates upon withdrawal. In any case, you should never let tax considerations alone drive your investment decisions. Be sure that your overall financial objectives guide your investment strategies.
Dividends - dividend income received by an individual shareholder from a domestic or qualified foreign company is taxed at a top rate of 15% and at 0% for taxpayers in the 10% or 15% tax brackets for 2009 and 2010. It is important to keep in mind that to receive a dividend that qualifies for the lower tax rate, you must buy the stock at least one day before the ex-dividend date and hold that stock for at least 60 more days. The ex-dividend date is the last date on which shareholders of record are entitled to receive the upcoming dividend. Essentially, what this means is that if you owned shares for only a short time around the ex-dividend date, your dividend income will be taxed as ordinary income and will not be eligible for the 15% rate. Keep in mind that some income payments called "dividends" may actually be interest income (e.g., earnings on money market funds).
Capital Gains - the maximum tax rate on net long-term capital gains is also 15% for 2009. If you're in the 10% or 15% tax brackets, your net long-term capital gains rate is 0% for 2009 and 2010. To qualify for long-term tax treatment, an asset must be held for more than one year before it is sold. For coins, art and other collectibles (including gold and other precious metals) held for more than one year, the maximum capital gains tax rate is 28%. Capital gains on investments held for one year or less are taxed at ordinary income tax rates.
Offset Capital Gains with Losses - if you have any capital gains, you can reduce your taxes by offsetting your gains against sales of investments that resulted in losses in 2009. If your capital losses exceed your capital gains, you can deduct up to $3,000 in net capital losses against ordinary income ($1,500 if married filing separately) or your total net loss as shown in 1040 Schedule D, Capital Gains and Losses, whichever is less. Excess losses that you could not deduct may be carried forward to future years and can be used to offset future gains. This is in addition to being able to deduct up to $3,000 in future years. It is very important to keep track of these unused losses and whether they are short-term or long-term losses.
Retirement Plans - we all know that a balanced portfolio of asset types is key to minimizing risks in an investment portfolio, but did you know that it's also important to have a balanced tax portfolio? Should you put more money in your employer-sponsored plan or mutual funds? Should you put more money in a Traditional IRA or a Roth IRA? Should you roll-over your Traditional IRA into a Roth IRA and pay the taxes now instead of at withdrawal? In 2010, there is no income limit to convert a Traditional IRA to a Roth IRA and you can choose to spread the tax impact over tax years 2011 and 2012, but whether to do so or not depends on a number of factors including the tax rate you will pay on the conversion, the source of funds to pay the taxes, the foregone investment return on those funds, and your expected tax rate at withdrawal.
At Altitude Financial Planning, we help you answer these questions as part of our Comprehensive Financial Planning process.
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