The new 3.8 percent net investment income tax imposed by Section 1411 (T.D. 9644 and REG-130843-13) is in effect and with a new year ahead now is a great time to review your portfolio and adjust where necessary to keep investments aligned with your financial goals and objectives.
Independent financial advisors are reviewing new tax-efficient products and portfolios in an effort to mitigate the repercussions of the new tax. The recommendations run the gamut, from investing in tax-deferred annuities, adding municipal bonds, favoring private equity over hedge funds and cleverly using trusts. In May, Baron’s published some tax-saving moves the best financial advisors are recommending to their clients to ease the hurt of the tax hikes. Before you make any decisions you will want to talk with your financial advisor and accountant to be sure you are making the right moves for your personal situation and your portfolio.
POSTPONE TAXES. Pursue as many tax-deferred opportunities as possible. Certain variable annuities have no limits on how much you can purchase and, consequently, let your investments grow tax deferred in underlying sub-accounts. The costs associated with variable-annuity can often exceed 3% of the value of the annuity. However, some annuity companies, such as Jackson National, and Sammons, have been quick to respond to the higher tax rates by launching variable annuities that are inexpensive, liquid and simple; they include a broad array of investment options, including alternative strategies. The real value of these annuities is their tax-deferment feature.
CONSIDER NON-QUALIFIED DEFERRED-COMPENSATION PLANS. These allow you to save a portion of pre-tax compensation and let it grow tax deferred until a specified date. These plans fell out of favor in 2008 and 2009, when many top executives lost millions in deferred compensation at the likes of Lehman Brothers and Circuit City. If your company goes bankrupt, your deferred-compensation may become subject to creditors’ claims. Business owners and self-employed taxpayers can defer taxes by setting up a defined-benefit plan, which is like a traditional pension structured to pay a certain lifetime annuity in retirement. For 2013, the maximum benefit you can fund equates to a $205,000 per year payout for life.
CONSTRUCT TRUSTS WISELY. Tax deferral and other benefits are benefits of charitable-remainder trusts. If you intend to leave assets to charity, do so with these trusts and in the process create your own tax-deferred retirement account. Upon funding the trust, you get a tax deduction based on the present value of your gift. For the term, your assets grow tax deferred in underlying investments, and you receive an annuity. The annuity is calculated to pay out all of the trust’s assets, except for the amount slated for charity. Consider funding the trust with a highly appreciated asset that you would like to sell to diversify. “If you transfer it to the trust, you can sell without any immediate tax impact,” says Allen Laufer, managing director at Silvercrest Asset Management in New York. “If instead, you sold your position outside the trust you would likely pay capital-gains taxes and the 3.8% Medicare tax, and reinvest a significantly smaller sum.”
ANALYZE AFTER-TAX INVESTMENT PICKS. Wealth advisors are making sure that individual investment choices create more tax-efficient portfolios overall. Creating more tax-efficient stock portfolios is critical.
RETHINK TRUST PAYOUTS. The new tax climate has been particularly hard on trusts. While individuals get hit with tax increases at varying high-income thresholds, the higher tax rates, including the 3.8% Medicare tax, punitively hit trust income in excess of just $11,950. “One way to address this is rather than reinvesting income in the trust, distribute it to beneficiaries — assuming they have lower tax brackets — earlier than the trust had intended,” says Jere Doyle, estate planning strategist at BNY Mellon.
“Use the same principle to avoid the new Medicare tax and the 20 percent capital-gains tax above $11,950 by distributing the trust’s appreciated asset to a beneficiary whose income is low enough to avoid the higher charges,” says Mitch Drossman, managing director at U.S. Trust. To avoid both the Medicare and highest capital-gains taxes, income of the beneficiary would have to be below $200,000 for singles and below $250,000 for a couple. “Then the beneficiary can sell it at a lower tax rate or give it to charity,” he says.
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