2/11/13 WSJ Article Presentation
“How to Be Smarter about Taxes: With Many Fund Investors Facing New Levies This Year, Here are Strategies for Reducing the Bite” by Michael A. Pollock. Wall Street Journal Online, 4 Feb 2013.
Available from http://libproxy.uww.edu:4064/docview/1283837659/13C1D29BFE42004CD6E/71?accountid=14791
Michael Pollock’s article discusses the tax implications of certain investment options, with a focus on recent changes in the tax law. He gives a number of example situations and presents the details (the problem) and various options for dealing with it.
The “fiscal-cliff agreement,” for example, raised tax rates on the highest income earners. Actively managed funds often have significantly more short-term capital gains than passive funds. Pollock recommends these high turnover options should be considered for tax deferred accounts such as IRAs and 401(k)s, especially for those in the higher income brackets because the gains are taxed at ordinary income rates. The 3.8% tax on investment income included in 2010’s new health care law only makes this more important. Because the market has gained back much of the losses of the past few years, there are also less carry-forward losses remaining. This means investors should consider if the fund has any unrealized losses still available because this will also make a difference outside of a tax-sheltered account.
Another example Pollock uses is for charitable giving. He lays out a way to donate securities that have increased in value to charity, deduct the full value of the shares, avoid paying capital gains on the appreciation, and even rebuy the shares again (now at a higher cost basis). Finally, he mentions tax-managed funds whose aim is to minimize taxable distributions.
The author defines some of the terms he uses in the article and here I will include two more. Index funds are mutual funds that are not actively managed. They mirror the makeup and performance of a certain defined fund of stocks, such as the S&P 500. As such, they tend to have low costs and low turnover. Unrealized losses come from selling a security for less than you paid for it. This can generally be used to offset any capital gains, even in future years. If a fund currently carries unrealized losses, it means they have sold some securities at a loss in the past but have not used them to offset any gains yet (so they are still available to do so).
This article relates to personal financial planning by touching on two main topics – investing and tax planning. Even if one does not invest in the stock market, the article still brings up relevant issues for anyone that pays taxes. Tax laws change over time and it makes sense to stay on top of current law and how it applies to your financial situation and goals.
The implication of the article is that your tax situation is important and should be considered when investing. The most critical consideration is whether you are meeting your investment objectives, but tax planning plays an important role within that overall strategy. And it is ultimately up to you to manage and understand what is best for you own situation.
I thought the article was interesting because it does deal with two different topics. I also thought it was beneficial to include specific benchmarks rather than general advice like “consult your tax advisor.” Two examples of this are the recommendation to look for 25% or less turnover to avoid short-term gains and distributed gains are more likely if the fund has an embedded gain of 30% or higher.