Episode 2: 2021 Tax Plan vs. Tax Prep Part 2
Jan 15, 2021
In our 2 part series, listen to Isaac and special guest Kevin Buenvenida tackle tax issues that need consideration when developing a financial plan. In addition, why reviewing your 1099’s and W-2 forms in the coming weeks needs more thought than simply turning them over to a software program or accountant.
Learn more about:
- Tax Strategies for your portfolio
- Mutual Funds – Unexpected Tax Issues
- Tax Harvesting
Isaac Wright: Hello. This is Isaac Wright from Wright Money Tips. We’re right down the middle of January. As you remember, from our last episode, we talked about having a two part series on taxes, trying to bring a little value right out of the gate. A lot of you now are going to start getting your 1099s and your W2’s coming up here over the next several weeks ahead.
Sometimes there’s some confusion around tax preparation versus tax planning. So just as a quick recap, we talked a little bit about in our last episode about taxes, relative to what an advisor should be looking for when it comes to added value if you’re hiring an advisor or if you have an advisor.
Tax planning is definitely a piece of the puzzle that needs to be addressed. But before we go into that today, I want to take a minute here, introduce our guest of the day, Kevin . Kevin is one of our advisors here at Financial Dynamics and Associates. And as we talked about earlier, he’ll be sitting for his CFP in March.
Are you feeling ready for that?
Kevin Buenvenida: As best as possible but I’m putting the work in.
Isaac Wright: So we have a lot of good things lined up today. But again, short sweet, but very powerful. I think, just to reset the tone, remember a lot of times people are worried about taxes. They have an accountant or a CPA, and they think that when they turn in their tax forms that they’re going to get tax advice. And a lot of times that’s not the case. They’re just getting what’s called tax prep. They’re getting prepared to be able to either hopefully get a refund back, maybe have to pay some in taxes. Unfortunately that has nothing to do with tax planning. What I want to do today is talk about what I would say are topics three and four.
So we have four things to cover in taxes, but the third thing, getting back into our tax discussion are mutual funds, having embedded gains. Now, Kevin, if you want to take that, tell me a little bit about what that means. What kind of problems can occur with owning mutual funds, not in a qualified or retirement account, but let’s call it a taxable brokerage account.
Sometimes these surprises come around at the end of the year of every year. We saw a few of those here in 2020.
Kevin Buenvenida: That’s right. And that is a fantastic topic to be talking about in terms of investing merging with the tax planning conversation. When we think about investing in taxable accounts, and this is by no means bashing mutual funds by any means, but just something to be mindful of when you think about investing and planning with that type of investment vehicle.
So the way mutual funds are structured is they own lots of different companies, lots of different investments inside that particular product or even strategy. Now that manager, or maybe it’s the smart people behind the scenes buying and selling those securities, might make a change in their portfolio.
Given market volatility or strategy changes. Every time they make a change, they might realize a profit on a position or a part of their strategy, which some investors get surprised they have to pass on that gain. To you as an owner of that mutual fund.
Isaac Wright: And let me, let me interrupt here because where people get confused as they get that tax bill, but they haven’t sold any of the mutual funds that they own.
So like, why am I getting a tax bill at the end of the year? Or whenever they decide to what I would call, report the taxes from all of those sales. And again, if the market, if you think about where the market’s been, it’s been up over 10 years. We’ve had a couple of little hiccups, but a lot of these, especially last year in March of 2020, when the market dropped 30%, a lot of people we’re redeeming mutual funds. So if these are mutual funds from taxes, just to be clear here, these taxes are sometimes again, they’re getting these kinds of reports. They may not have gotten them so much in the past, but now with redemptions may have gotten a larger tax bill. I didn’t want to cut you off, but that’s the thing.
It’s a crazy thing that we see when people are upset when they get that. They’re like, “Hey, I didn’t sell any mutual fund shares.”
Kevin Buenvenida: Well, we think about the beauty of the mutual fund product and the structure you get that immediate diversification and an easy way to basically manage a stable of products or strategies together in a succinct fashion.
But one of the inefficiencies when it comes to investing in mutual funds from a tax planning standpoint is definitely getting surprised by both the capital gains distributions towards the tail end of the year, as well as not acknowledging, maybe, the timing of when to own some of these investments depending on those capital gains distributions.
And by law, the way that basically the fund companies are set up, they have to send out these capital gains distributions to their investors.
Isaac Wright: So we want people to realize not to say mutual funds are bad, it gives you good diversification if you have the right mutual fund mix. There’s also in our opinion I think, a good way to own individual stocks and build out a portfolio that you have a lot more control when you have individual stocks in a portfolio that’s being managed.
For example, here at our firm, we can help determine timing in terms of when maybe to buy and sell. And figure out necessarily in the grand scheme not say November or December, but all throughout the year, an opportunity to help minimize some of those taxes to be able to offset gains with losses. We’re going to talk about that here in a quick second.
But a lot of you are receiving tax forms on mutual funds that you never sold a share on. And we want to make sure you understand that there’s some other opportunities. Again, if you have any concerns you can reach out. Also if you go to Wright Money Tips, we have a white paper, an election report that really breaks down some things we see on taxes.
Again, you can reach out to us here at (804) . But Kevin, anything you want to say about mutual funds before we move on? I think we covered that pretty well. Again, especially if you own active managed mutual funds, a lot of people are spending money and there’s additional fees sometimes included in how those funds are going to be operated.
We can cover all of that with you as well. Let’s move on to the fourth topic, our final topic in the month of January, when we’re talking here about taxes. I kind of hinted to this already. But the fourth way that an advisor here at our office and almost any other office, if you have a good advisor, should be looking at taxes and tax planning is what we call ongoing tax harvesting.
That’s a lot to say, but tax harvesting. Let’s talk a little bit about that, Kevin. Why don’t you just give a general description of what tax harvesting is and how that can help an individual investor.
Kevin Buenvenida: Absolutely. So let’s take the example of investing in a taxable brokerage account, whether that might be in your name only ,or maybe a joint account and with somebody else.
And you own a series or a handful of different companies, let’s say Google for example, and at some point down the road here, you decide to sell that stock for a profit. What a good advisor, or maybe somebody who is being cognizant of the implications of taxes with investing is, now that you’ve realized the game, you’re going to owe Uncle Sam some sort of tax on that profit.
But as you think about your long-term strategy, review maybe some of the other holdings that you have for potential losses. So you can take a look at some of your other investments within a game plan of targeting strategic sales, to realize a loss to either minimize that gain you just realized, or potentially completely offset.
Isaac Wright: Well, Ricky and I talked about this in our last episode about stocks that have had a huge run and, and sometimes that causes highly concentrated stock positions in a portfolio. Well, in a way, even though certain stocks this year, so example like for 2020, technology stocks did really good. But other than technology stocks, really the market struggled.
And so you may have been able to offset some gains with losses and other stocks. So you know, energy stocks were beaten up a little bit, real estate, and so forth. But, the thing about tax harvesting is, and I’m saying you as the investor, shouldn’t have to reach out to someone and say, “Hey, what are we doing here about taxes?”
There should be an ongoing strategy that’s implemented with the taxable portion of your assets. To know, generally speaking, when an asset could be sold, when it could be bought. We have portfolio teams that actually oversee and overview those types of investments for tax harvesting strategies.
And if you remember what I said in our last episode, over the past several years, there have been articles suggesting investment returns can increase 1% to as much as 3% annually. If tax planning is considered when making decisions around your portfolio. Again, some of that may be the jury is out on, but let me just put it this way.
If you can minimize Uncle Sam out of the equation, typically, you’re going to come out ahead. I also want to say this as a note to what Kevin was saying about tax harvesting as well. Those gains and losses, we also need to pay attention to the tax bracket that they are in as well. Do you want to talk a little bit about that because if you have a low tax bracket, maybe capital gains or harvesting is not as important as if you were in the higher end tax tiers because capital gains are taxed at different rates than ordinary income rates.
Kevin Buenvenida: Absolutely. So that’s a great comparison of the way the government is structured, taxation of capital gains. If you own an investment for less than one year and you sell it for a profit, Uncle Sam knocks on your door for an ordinary tax rate onthat capital gain. But when you own an investment for longer than one year, you actually get favorable tax treatment with potentially as low as 0% tax rate on a long-term capital gain if you’re in a low enough tax bracket or as high as 20%.
So, depending on where you fall into your ordinary income filing based on your pension, social security, ordinary income that you gain, you might find yourself in an advantageous position to realize long-term taxable gains at attractive tax rates in comparison to ordinary income tax rates.
Isaac Wright: And for those of you who do what I call, do it yourself investing, and you sell a stock for a loss, also keep in mind that to be able to claim losses and really take advantage of some of the tax harvesting, you have to be careful of what’s called the Wash Sale Rule. Which means that you can’t sell a stock for a large loss and turn around and buy it the next day.
You have to wait 30 days. And then also, depending upon the strategy you’re trying to implement, you may be able to go in and buy something similar in maybe another industry, or similar industry, excuse me. But to make a long story short, what you’ve heard here for the month of January tax harvesting, you know, making sure that your understanding of how to take advantage of highly appreciated stock, asset locations, all of the things that we’ve covered here in January. If you have any concerns about taxes, maybe where taxes are headed.
If you have any concerns or questions, you can visit wrightmoneytips.com to request some time on our calendar Or please subscribe when visiting wrightmoneytips.com to receive notifications on new episodes, our newsletter and even upcoming events.
Well, with that being said, Kevin, I think that’s going to conclude our episode here on Wright Money Tips, moving right along into February. Looking forward to having another episode in a couple of weeks, we’ll talk soon.