Well, April 15th has come and gone.  Following that date, many taxpayers become intimately familiar with Ms. Pelosi’s comment about having to pass Obamacare to find out what’s in it.  The increased tax paid by many individuals has caused us to evaluate (again) some tax strategies for investing.  We have always maintained that the “tax tail shouldn’t wag the investment dog;” however, tax impact certainly warrants consideration all other things being equal.


Many events can impact taxes in the investment arena.  After all, the primary goal of investing is to maximize the after tax return to the portfolio for the risk level chosen. Three general rules apply:

  1. Avoid taxes if legally possible
  2. Defer taxes until a future date
  3. Then if 1 and 2 are not practical, pay the taxes at the lowest rate possible.

With these general rules in mind, let’s discuss some investment strategies with income tax ramifications.

Investment selections

The investment chosen has tax ramifications.  Mutual funds buy and sell stock throughout the year.  Those transactions generate capital gains (hopefully) which are passed on to the mutual fund owner who is responsible for the income taxes on the gain (in taxable accounts) Therefore, portfolio turnover (how often the mutual fund manager buys and sells) can be a factor in investment selection.  Index funds generally have lower turnover than actively managed funds.  Municipal funds can provide income free from income tax and the Obama care surtax.

Investment Location

Some accounts defer taxes until the future (IRAs, 401(k)s, and other tax qualified plans.  As such, these accounts are generally more suitable for investments with a higher known return (such as taxable bond funds in a historical interest rate environment).  Note that losses on investments are not deductible when they occur in such a qualified account.

Tax Loss Harvesting

This strategy utilizes general rule 1: don’t pay taxes.  In taxable accounts, gains on one investment may be offset by the loss on another investment, a net zero addition to taxable income.   You can also offset ordinary income up to $3000 per year with losses that exceed gains.

Withdrawal Strategies

As a general rule, spend from taxable accounts first, and then from tax deferred accounts.  Some caveats to this general rule exist.  IRAs have required minimum distributions (RMD) requirements that begin at age 70½. If these RMD amounts are such that they might increase the tax bracket in later years, consideration should be given to earlier withdrawal.

Roth IRA Conversion

Roth IRAs do not allow tax deductions for contributions to the account; however no required minimum distribution is required from the account and the investments grow tax free (not tax deferred).   Contribution limits apply to such an account depending on the investor’s income level.  Funds from existing qualified accounts can be rolled into a Roth IRA regardless of income earned.  A Roth conversion strategy does require payment of taxes on the amount rolled into a Roth account.  It works best if the investor has outside funds with which to pay the taxes.  Planning techniques exist for these conversions that we will not discuss here but that do potentially affect taxes on the amount converted.

At Paragon Financial Advisors we do not prepare taxes and urge you to consult your tax professional for your personal circumstances.  However, we can assist you in planning your investment strategies to minimize the “April 15th” effect.  Paragon Financial Advisors is a fee-onlyregistered investment advisory company located in College Station, Texas. We offer financial planning and investment management.

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