Fall is such a wonderful time of year. I love the local harvest festivals and the earthy colors of the season. It is also the time of year when Financial Advisors think of tax harvesting which is a term that they use when reviewing portfolios for tax efficiency and thinking about how to offset gains and losses. Let’s review how that works. A long term capital gain is the amount that you have earned over the amount invested for more than a year. If that investment is sold, then the capital gain portion is taxed at 15% (federal tax) maximum – not your tax bracket. If your capital losses exceed your capital gains, the amount of the excess loss that can be claimed is limited to $3,000, (or $1,500 if you are married filing separately). If your net capital loss is more than this limit, you can carry the loss forward to later years.
When an Advisor reviews your asset allocation, they will keep these tax rules in mind. First of all it is in the client’s best interest to review the asset allocation once a year and second, it is in the client’s best interest to keep the client’s tax liability as low as possible. After all, it’s not what you earn but what you keep that counts. That is how wealth is accumulated.
If your portfolio has active funds, then you will get a statement from the fund estimating what the capital gain distribution will be. Usually you will get this at the very end of the year when it’s too late to do anything about it. This is just another reason why I like passive funds and ETFs (exchange traded funds). However, if you do own active funds outside of retirement plans, you should know how tax efficient that fund is. Find out how yours is doing with the Lipper’s tax – efficiency rating system (www.LipperWeb.com). This is important since you may not sell the fund that year but get a whooping tax bill on a large capital gain distribution from them – a bad surprise for sure.
A good strategy that I highly recommend is to keep all your dividend paying funds (bonds and large companies) in retirement plans and keep your tax efficient funds in taxable accounts.
Coaching Question – How can you make your portfolio more tax efficient?