Managing Your Taxable Investments
As a full-service financial planning firm, we address many issues regarding our clients’ finances. For example, over the years, we have advised many clients on how best to manage the tax ramifications of repositioning a taxable portfolio. Unlike changes in qualified retirement plans and IRAs, recommending changes in taxable accounts can be complicated when significant gains and/or losses are involved.
Investors need to weigh the costs and benefits of the transaction. When a gain is involved, the main benefit is realization of the gain and possible protection of that gain, with the ability to reinvest or spend some of the money that is freed up by the sale. The cost, however, is the taxes that will need to be paid on that gain. The good news is that the tax is based on the gain on the sale and not on the total proceeds. In addition, the rate on capital gains is generally lower than the rate on other types of income, such as salary which is taxed at ordinary taxes rates.
To illustrate, we will take the hypothetical case of George and Gina Stewart. They are in their early 60s and in the final push for retirement. George currently has stock from his previous employer that he obtained through options that were granted him. He was able to buy 5000 shares of stock at $5 per share and now, 10 years later, they are worth $80 per share. Up until now, the Stewarts had resisted selling any stock because they were both still working, did not need the income, and wanted to defer paying taxes on any gains till they needed the money during retirement. Now that retirement was nearing, they wanted to come up with a plan to turn those appreciated shares into cash while minimizing the tax ramifications.
Our first step was to calculate what the gain would be if stock were sold today. Currently, that would be $75 per share of stock sold.
Second, we charted out cash flow needs over the next 5 years. When would they would be eligible for Social Security and other pensions? The issue now was when to sell. If we sold all today, we would have an enormous gain of $375k and a potential tax bill of $75k. However, the Stewarts would still net $325k ($400k-$75k), a nice return on a $25k investment. The couple still liked the stock and saw no need to sell it all now, but we were not guaranteed that the stock would continue to grow and worried about the stock falling sometime within the next 5 years.
Upon review of their other holdings, we noticed that some smaller positons had losses. Since you can offset gains with losses, we looked at possibly selling just enough shares to take advantage of the losses and minimize the capital gains taxes. We also discussed putting upper and lower limits on the stock price where we would sell some to lock in gains and minimize losses.
In the end, we came up with a plan to trim the stock over the next 5 years, which would give the Stewarts the cash they need during retirement and minimize the tax effects of the sale.
When it comes to investing, once must always consider taxes when evaluating a taxable portfolio and come up with a strategy to mitigate them. Protecting gains by selling high may leave you with more money than selling when the stock falls.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. This information is not intended to be a substitute for specific individualized tax advice. We suggest that you discuss your specific tax issues with a qualified tax advisor.
