Personal Finance: It's time to make tax moves
If it's November, it's time to consider some year-end tax moves.
Every year at around this time, investors have one last chance to take advantage of some tax breaks that Uncle Sam offers. The end of the year is also a great time to make sure your portfolio is well positioned for the start of the following year.
Now, you may wonder if it's even necessary to worry about investment taxes, since they've fallen in recent years. Long-term capital gains are now taxed at a maximum rate of just 15 percent, down from 20 percent in the past. And taxes on qualified dividends are also capped at 15 percent, down from as high as 38.6 percent at the start of the decade.
But think of it this way: The Standard & Poor's 500 Index of blue-chip stocks is up only around 2 percent so far this year. Yet taxes, on an annual basis, can easily eat away 1 or 2 percentage points in returns. In other words, taxes in modest years can chew up most of your investment gains.
So what moves should you be considering?
1. Rebalance your portfolio in a tax-efficient way. Once a year, savvy investors typically rebalance their portfolios—in other words, they make sure that their mix of stocks, bonds, and cash is appropriate for their investment needs. The good news is, many investors hold at least some portion of their money in tax-deferred accounts, such as 401(k)'s or IRAs. If you're thinking of rebalancing your portfolio by trimming your positions in winning stock funds, consider selling shares held in your 401(k)'s and IRAs first. That's because booking capital gains in a tax-deferred account does not trigger taxes.
2. Harvest losses in your portfolio. Just as investors can realize taxable capital gains, they can book capital losses by selling stocks at prices that are below what they originally paid. If you decide to sell stocks that are underwater this year, you can use those losses to offset capital gains that you've realized elsewhere in your portfolio, thereby reducing your tax bill. Even if you have no gains to offset this year, you can still realize losses and use them to reduce up to $3,000 in ordinary income.
3. Make gifts of appreciated stock. You can give stock away to a charity or even to your children. If you were planning to donate money to a charity, think about making that donation instead in the form of appreciated stock. This way, you avoid having to pay capital gains on the appreciated shares, and you get to claim a tax deduction on the full market value of the shares. Meanwhile, the charity can sell the stock on its own without tax consequences. If you're donating to your children, they can turn around and sell the shares at their lower capital-gains-tax rate, which will typically be 5 percent instead of 15 percent.
4. Take full advantage of your catch-up contributions. The federal government allows workers who are 50 or older a chance to make extra "catch-up" contributions to their 401(k)'s and IRAs—over and above what they're typically allowed to put into such accounts. This year, workers 50 or older can stuff an extra $4,000 into their 401(k)'s (that figure jumps to $5,000 in 2006) and an additional $500 into their IRAs (rising to $1,000 in 2006).
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