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“There Goes that Bracelet for her Arm, There Goes that New Fence for my Farm” – Johnny Cash, After Taxes

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It’s not what you make that matters, it’s what you keep and investors would be remiss to forget the old adage. The government taxes investment gains in non-qualified accounts if and when the assets are sold. Therefor any investor who wishes to maximize after-tax wealth, and has experienced gains in their taxable portfolio must eventually face a crucial decision – sell now and pay the tax on the gain, or continue to hold the securities and risk the unknown – i.e. potentially having to sell the investment under less favorable conditions in the future.

Deferring taxes and thereby keeping more of your portfolio in tact may allow the deferred funds to compound over time and remains one of the key pillars in effective tax management. A clearer understanding of the potential benefits of tax deferral can allow investors to make better, more informed decisions. With tax rates finally settled for the near future, you may be asking yourself why it matters when I sell my investment and pay the tax. If the rates aren’t going to change anytime soon then pay now, pay later…have to pay eventually right? Well it can matter quite a bit, and deferring taxes on investment gains can be an effective strategy for long-term investors under many tax rate environments.

To illustrate this concept let’s look at a simple example comparing two identical portfolios, but with one key difference: one portfolio realizes gains on an ongoing basis each year, and the other defers them to be realized in the future. The first portfolio is assumed to grow at 8% per year (all capital gains) and at the end of each year the gains are realized and taxed at long-term capital gains rates. The rate on capital gains is assumed to be 23.8% (20% maximum rate, plus 3.8% surtax). For the second portfolio, we assume that the portfolio grows at 8% which again is all capital gains. However, in this portfolio nothing is sold and the gains are therefore deferred each year until year 10, at which point all gains are realized and a rate of 23.8% is paid on long term gains. The difference between the two portfolios illustrates the potential tax deferral benefit.

The example shows there may be a significant benefit to a tax deferral strategy even if you don’t expect lower tax rates in the future. The magnitude of the deferral benefit depends on a number of variables, and those benefits can be maximized with careful planning and execution. There are also other potential outcomes and strategies that investors should be aware of. Those looking to donate assets to charity should consider donating their appreciated securities. This strategy may lead to an avoidance of capital gains tax altogether. It is also important to keep in mind that assets held until death will receive a step-up in basis, again potentially avoiding a capital gains tax. Evaluating the benefits of deferral vs. realization in taxable accounts is a key consideration in any trade decision that RegentAtlantic makes for our clients. Some of the important variables to consider include the amount of the gain in question, the tax rate, the expected return on the replacement asset (i.e. what you buy with your sale proceeds), and the potential diversification benefits of the replacement asset.

If you would like to hear more about how you might minimize the impact of taxes on your portfolio, you might benefit from asking a RegentAtlantic Wealth Advisor about our Second Opinion Portfolio Analysis.

 

Important Disclosure Information

Please remember that different types of investments involve varying degrees of risk, including the loss of money invested.  Past performance may not be indicative of future results. Therefore, it should not be assumed that future performance of any specific investment or investment strategy, including the investments or investment strategies recommended or undertaken by RegentAtlantic Capital, LLC (“RegentAtlantic”) will be profitable. Please remember to contact RegentAtlantic if there are any changes in your personal or financial situation or investment objectives for the purpose of reviewing our previous recommendations and services, or if you wish to impose, add, or modify any reasonable restrictions to our investment management services. A copy of our current written disclosure statement discussing our advisory services and fees is available for your review upon request. This article is not a substitute for personalized advice from RegentAtlantic.  This information is current only as of the date on which it was sent.  The statements and opinions expressed are, however, subject to change without notice based on market and other conditions and may differ from opinions expressed in other businesses and activities of RegentAtlantic.  Descriptions of RegentAtlantic’s process and strategies are based on general practice and we may make exceptions in specific cases. For the above chart, it is assumed that the first portfolio grows at 8% per year which is all capital gains and realized and taxed and the end of each year as the long term capital gains are recognized.  The rate on capital gains is assumed to be 23.8% (20% maximum rate, plus 3.8% surtax).  For the second portfolio, we assume that the portfolio grows at 8% per year which is all capital gains and is deferred each year until year 10, when all gains are realized and a rate of 23.8% is paid on long term gains.  The difference between the two portfolios illustrates the tax deferral. Please remember that RegentAtlantic does not provide tax advice.  Please consult with a tax advisor of your choosing prior to implementing any of the strategies discussed in this article.  This information is based on RegentAtlantic’s current understanding of tax legislation.  Congress may change the legislation at any time.

Important disclosure information

Please remember that different types of investments involve varying degrees of risk, including the loss of money invested. Past performance may not be indicative of future results. Therefore, it should not be assumed that future performance of any specific investment or investment strategy, including the investments or investment strategies recommended or undertaken by RegentAtlantic Capital, LLC (“RegentAtlantic”) will be profitable.

Please remember to contact RegentAtlantic if there are any changes in your personal or financial situation or investment objectives for the purpose of reviewing our previous recommendations and services, or if you wish to impose, add, or modify any reasonable restrictions to our investment management services. A copy of our current written disclosure statement discussing our advisory services and fees is available for your review upon request.

This article is not a substitute for personalized advice from RegentAtlantic. This article is current only as of the date on which it was sent. The statements and opinions expressed are, however, subject to change without notice based on market and other conditions and may differ from opinions expressed in other businesses and activities of RegentAtlantic. Descriptions of RegentAtlantic’s process and strategies are based on general practice and we may make exceptions in specific cases.

RegentAtlantic does not provide legal or tax advice. Please consult with a legal and or tax professional of your choosing prior to implementing any of the strategies discussed in this article.

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