For most investors, 2017 was a very good year. And with all good years comes hefty tax consequences, which can take a big bite out of your overall returns.
To cushion the blow, Mark Avallone, president and founder of Potomac Wealth Advisors, offers some tax-planning strategies to shelter your investments as much as possible.
Here are his six tips to consider now to reduce that tax bill later:
With combined federal and state capital gains rates totaling more than 30 percent, buy-and-hold strategies may be a good option to avoid capital gains for 2017. For many investors, the tax efficiency offered by ordinary index mutual funds, like the Vanguard 500 Index fund (VFINX), for example, is a good way to go.
With a huge run-up like this, some people are a little over their skis, Avallone said. If you started out with a 50/50 stock allocation a few years ago, you could be well above that now. But that doesn't mean you have to sell something to buy something else. Rather than unloading a winner (and having to pay tax on those gains), use cash that's sitting on the sidelines from dividends or earned interest to rebalance.
At the same time, consider selling investments that are at a loss to generate a tax deduction. Scour your portfolio for any losers, like Under Armour or GE, Avallone said. Tax-loss harvesting enables you to realize annual net investment losses of up to $3,000, which can be used to lower taxable income or offset gains. But be careful how you reinvest those proceeds, he cautioned, to avoid the "wash sale rule " (if you reinvest that cash in a substantially identical investment during a 30-day window before or after the sale, then you can no longer book the loss for tax purposes).
Meanwhile, if you're holding bonds in your investment portfolio, consider moving them to tax-deferred retirement plans like an IRA or 401(k). Most bonds pay interest that gets taxed at ordinary income tax rates. If, instead, they are held in a retirement plan account, that could result in significant tax savings not just this year but in future years, too.
Of course, it's a good time to put cash in a tax-free retirement account as well. You can contribute up to $5,500 annually or $6,500 if you are over age 50, which can be tax deductible in certain circumstances. These limits apply to all IRAs combined so that there is no "double dipping." (But there is also a Saver's Credit, which can be taken for contributions to a 401(k), traditional, Roth IRA or SEP, of up to $2,000 — or $4,000 if married and filing jointly — depending on your income. So in this case, you can double dip.)
You may be able to convert funds from your employer-sponsored retirement plan or traditional IRA into a Roth IRA. You will have to pay taxes on the amount converted as ordinary income but younger investors will have a long time to then potentially grow the Roth IRA account and make up for it. (While funded with after-tax dollars, any earnings and withdrawals in retirement are tax-free.)