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Preparing Your Portfolio for Higher Taxes

Posted August 08, 2012 in Advice Column, Clive

Is your portfolio ready for higher taxes? Here are some ways to shelter your assets before new rates kick in.
    •    Sell your winners early. The usual advice on taxes is to defer them as long as possible, but if rates are going to rise, you might want to stand that advice on its head. It might be better to sell your winners before rates rise.  Pay 15 percent rather than 23 percent next year.

•    Buy municipal bonds. Muni-bond income is generally free from federal taxes and from taxes in the issuing municipality. That is a big advantage over corporate and treasury bonds.  Usually, munies offer lower gross yields than the equivalent taxable bonds. Not the case today. A 30-year triple-A-rated municipal bond may yield about 3.5 percent. Thirty-year treasuries yield 2.6 percent. After taking taxes into consideration at 35 percent that yield drops to 1.7 percent.

    •    Buy a home. You primary residence is a great tax shelter. When you sell, your first $250,000 in capital gains is tax-free. That rises to $500,000 for joint filers. If you already own, you can up your investment by remodeling in a manner that adds value. This wouldn’t make sense if real estate were expensive: Few who bought six years ago have any capital gains to protect. But house prices nationwide are at their cheapest levels, compared with rents or household incomes, since the 1990s. And homeowners can finance purchases at less than 4 percent interest.

    • Max out your Roth IRA. In an era of rising taxes, the Roth could be a great tax shelter. You contribute with money after paying today’s tax rates. You withdraw money tax-free later when rates presumably will be higher. There are two ways to max out your Roth this year. First, you can contribute $5,000 per person — $6,000 if you are 50 or older. Second, you can convert your regular IRAs to Roth accounts. You will have to pay income tax on the money converted.

    •    Check the math on your 401(k). The standard financial advice has been to max out 401(k) contributions. But if taxes rise sharply ahead, it may not be that simple. Contributions to a 401(k) are tax-deductible today, but all the money withdrawn will be subject to income tax. This makes sense if you think your tax rate will be lower in retirement than it is today. Many investors could face big, unexpected tax hits on their 401(k) withdrawals when they retire. Some employers offer a Roth 401(k). Like a Roth IRA, you contribute with after-tax dollars today, but future withdrawals are tax-free. You also may have the chance to convert your current 401(k) account into a Roth.

•    Contribute to a 529 college savings plan for your children’s tuition. You contribute after-tax dollars and get a deduction on your Iowa return. In a 529 plan, withdrawals are tax-free if spent on qualified education expenses.

Tax laws are changing, and everyone’s circumstances are different. Check with a CPA or CFP before making a move.

Information provided by Steve Forrest, MBA, CPA/PFS, CFP® and Pete Deacon MBA, CPA, CFP®, Forrest Financial Services, L.L.C., Windsor Heights,, 277-3495.

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