Year-End Financial Moves – Advice from Wealth Managers compiled by David Gaino, CPA, MTax, PFS | Chairman Emeritus/Principal – Tax, Apple Growth Partners
As we approach the end of the tax year, it’s always a good idea to review your portfolio for tax opportunities and possible re-alignment for the new year. Given the impact of this historic election year, the need to review your portfolio is of utmost importance. We interviewed some of the area’s most well regarded wealth managers, as well as our tax team, to provide this summary of year-end considerations for you.
Question 1. I normally review my portfolio for gains and losses I can “harvest” to offset these gains and losses. Are there any special considerations?
In short, YES! 2016 has been a volatile year in the markets. We have seen continued movement from mutual funds to exchange traded funds commonly known as ETF’s. As a result, your mutual funds could hold a tax surprise. Each year mutual funds report your share of capital gain or loss. We anticipate 2016 will be a year of higher than normal capital gains as funds sold positions that may have been long held. It’s not as easy to discover these gains in your monthly reports. Make sure your financial advisor is obtaining the information for you so you know precisely how much capital loss to “harvest” to offset gains lurking in your mutual funds!
There is one additional point to consider on this topic. With the Republican sweep and pledge to reduce taxes, a dollar of capital loss is expected to be worth 3.8% more if taken in 2016 than 2017. You find this savings percent by comparing your capital gain tax bracket in 2016 to what we anticipate it could be in 2017. While Trump’s proposed tax plan for capital gain rates would apparently remain unchanged, the repeal of the 3.8% net investment income tax imposed on passive income (including capital gains) has been proposed. This rate varies by income category, so make sure your tax advisor shows you the savings potential if you have large losses that could be “harvested” this year versus next.
Question 2. I review my estate plan with my CPA and attorney annually. With the uncertainty of the estate tax in the upcoming years, how would you advise investing right now?
From an investing standpoint, your portfolio should reflect your investment time horizon and your risk tolerance. The estate tax issue needs to be addressed with your estate plan (trusts, gifting, etc.). In the past, when the issue of the estate tax being repealed was contemplated, it was often discussed that the step-up in cost basis would also be eliminated. If these two things were to happen, it could change your investment strategy. Without a step-up in cost basis, income tax on unrealized gains on inherited assets would be paid by beneficiaries. Some clients may want to realize the gains themselves instead of passing them along to their heirs who may be in a higher tax bracket.
Question 3. Given the election results, are there any adjustments to my investment strategy that I should consider?
The answer is, “it depends.” It depends on your investment strategy before the election. If you used a strategy of maximizing global diversity before the election, sometimes referred to as Modern Portfolio Theory, Bruce advises to continue your strategy into the New Year.
Conversely, if you were using a market timing or similar stock selection strategy, or perhaps were hunkered down with cash, bonds, or precious metals to hedge your bets, it’s time to consider a globally diversified portfolio with a re-balancing discipline that can help you cope with expected volatility in financial markets.
Question 4. With all of the uncertainty in the market due to proposed interest rate hikes, is there anything I should focus on or change in my investment portfolio?
A-1 Kelly Kuennen
The apparent path of interest rates over the next couple of years is up. Currently rates are well below their long-term average and we do anticipate they will revert back to a higher level. When interest rates rise, bond prices fall. Even though a bond’s price may fall, the bond will continue to pay interest, but that interest payment may not be able to overcome the reduction in value. The bottom line is that the returns on high quality bonds will be challenged as we move into the future. To address this issue in your portfolio you can reduce or eliminate your exposure to interest sensitive bonds and replace them with variable rate instruments and/or you can hold individual bonds to maturity. Stable value accounts can also provide the traditional stability of bonds without the interest rate risk. If rising interest rates are accompanied by inflation, inflation protected bonds are another option for your portfolio.
Question 5. I hear President-elect Trump’s policies may favor certain industries or market sectors. Should I position my portfolio to take advantage of this expected change?
A-1 Bruce Jentner
Whether you call this Market Timing or Value Investing, studies have shown it is extremely difficult for investors to pick the winners at the right time in advance of market moves. The securities markets move at lightning speed based upon ever changing real time information. Studies continue to show a disciplined and highly diversified balanced portfolio is a winning strategy.
Question 6. I am 75 years old and passed down my business to my kids (approximately 45 years old). What investment advice would you give to myself and my kids with the future unknowns? How would it differ?
A-1 Kelly Kuennen
Throughout history, the investment environment has always been and will always be filled with future unknowns. We are always faced with the economic cycle. By diversifying your portfolio, you can reduce the extreme up and down volatility but it is impossible to eliminate all risks and that includes inflation risk. Every position in your portfolio should have a purpose. Sometimes that purpose is for long-term growth, for income, or to hedge against a perceived or anticipated risk. These different factors need to weighed and allocated based on your time horizons and your risk tolerance. Your allocation typically will not remain static. It does need to be adjusted based on the economic and market environments.
Question 7. This is the first year I will have to take a Required Minimum Distribution (RMD) from my retirement account. With the markets and tax brackets at relatively high points, are there any planning techniques I should consider?
A-1 Jason DiLauro
There is a provision in the law that allows a charitable donation to be made directly from an IRA account to a charity. With tax rates at a higher level this year than expected next year, this would be a good time to utilize this technique to fulfill your charitable objectives and save tax dollars! There are rules and limits so seek tax advice before proceeding.
A-2 Paul Martin
The technique Jason mentions can be very powerful, but has certain limits set forth in tax law. The qualifying charitable distributions provisions permit taxpayers to donate directly to charity from an IRA. There is a $100,000 deduction limit per taxpayer (up to $200,000 for married couples). The money MUST be transferred directly from the IRA to the qualified charitable organization in order to be tax-free. In addition, the transfer has to come from an IRA and NOT a 401(k). One large benefit is that the qualifying charitable distribution counts against your RMD.
There are also many significant tax benefits. The tax benefits include: avoiding the 50% limitation on charitable contributions, reducing the chance of itemized deduction and personal exemption phase-outs, lower AGI, and potentially avoid state tax on the distribution. In Ohio, you would normally pay state tax on a taxable IRA distribution; however, the qualifying charitable distribution from your IRA would avoid Ohio tax since it is never included in your AGI.
Question 8. I was more than a little anxious about my portfolio before the election and moved a great deal of my portfolio to cash and bonds. The market took off post-election more quickly than my confidence level and I still have significant funds I wish I would have allocated to equities. Is it too late to make a move now?
A-1 Bruce Jentner
This is a great question and one I’ve gotten several times lately. In short, waiting to time an entry into the market is risky, too. Putting your funds “to work” in a balanced portfolio means some investments you’ll be buying on the cheap. For example, long-term bonds are down 4% since the election. Others may appear to be at a premium, but re-balancing over time has been shown to be a prudent and winning strategy.
As always, we at AGP stand ready to help with any year-end tax planning questions you may have. Please contact your engagement team leader if we can assist with your investment tax and portfolio review.