6 Year-End Tax Strategies for Your Investment Portfolio

If you've built or inherited an investment portfolio alongside the savings in your retirement accounts, you're likely to face some taxation every year on things like interest, dividends, and capital gains generated from those investments. These might be investments such as stocks, bonds, mutual funds, or ETFs, for example, held in a brokerage account, just to name a few.

While these investments can serve as a fantastic complement to your other retirement savings, you'll want to be sure to manage this money in the most tax-efficient manner each year to allow your money to last as long as possible.

Welcome, everyone, to the Retired-ish podcast. If you're a first-time listener or just stopping by to check out what we're all about, be ready for an action-packed list of last-minute considerations to help you make your investment portfolio a little more tax-efficient. And if you're one of our loyal listeners, stay tuned for some reminders on some different ways you and your advisors can save money in taxes heading into year-end before it's too late.

That being said, today, I'm covering six year-end strategies to consider in order to minimize your tax bill on investments held in non-retirement accounts. These can be accounts such as a brokerage account in your name only, a TOD account, AKA transfer on death account, that is a brokerage account in your name but has beneficiaries listed. It could be a joint brokerage account or maybe an investment account in the name of your living trust. It might even be a brokerage account in your name that is simply holding some former employer stock that you're still holding on to. Collectively, I will just refer to these as non-retirement accounts.

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I am not talking about retirement accounts such as IRAs, Roth IRAs, 401(k)s, and the like. Those types of accounts are subject to very different rules when it comes to taxation. These non-retirement accounts typically have at least some tax ramifications each and every year, whether or not you take any withdrawals from the account or make any trades, so to speak. For example, if you hold a portfolio of individual stocks in the name of your trust, those stocks may pay a dividend on a quarterly basis, and you might reinvest those dividends as soon as they are received. Even though a dividend check wasn't sent to you in the mail in this case, that dividend is still subject to taxes in the year received.

Then, there are multiple ways that dividends can be taxed, either at ordinary income rates, which are your regular federal income tax rates, or at the lower qualified dividend rates. Let's say you've held some of those stocks for decades or maybe inherited them. Depending upon your cost or what you paid for the stock or the value of it when you inherited it, you might be subject to capital gains taxes when you sell some or all of the shares of that stock in the year of the sale, similar to selling real estate at a gain.

Similar to dividends, capital gains can also be taxed in different ways. Short-term capital gains are taxed at ordinary rates, and long-term capital gains are taxed at the more preferential capital gains rates. The name of the game is to one, avoid the high taxes on short-term capital gains and ordinary income, which can be up to 40.8% for those in the highest income tax bracket, and two, lower the taxes to 0, or if you can't do that, lower them to 23.8% or less by making the profits subject to long term capital gains taxes.

Here's another way to think of this concept. You could be paying a nearly 72% higher rate when you pay 40.8% versus 23.8%. That's a big difference, especially when compounded over multiple decades. Tens of 1,000’s, if not 100’s of 1,000’s of dollars. This is why this stuff is so important.

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Let's look at some ways we can try to avoid the higher tax rates and take advantage of the lower rates. And this isn't sorcery or anything suspect; it's the tax code we were given. So it's all about how we use it to our advantage. Now, before we dive into the six strategies, it's important to first understand the seven basic tax rules you need to know when it comes to these investment portfolios. These rules will also explain where I got those percentages from what I mentioned earlier.

Number one, on your short-term capital gains and ordinary income, you pay federal income taxes at rates of up to 40.8%. The 40.8% applies to those in the current highest federal income tax bracket of 37%. Plus, there's an additional 3.8% tax on net investment income. Now, this is technically known as the net investment income tax or NIT.

Number two, you pay taxes on your long-term capital gains at rates ranging between 0%, so nothing, and 23.8%, depending on your income level. Technically, the percent or the capital gains rates are 0%, 15%, and 20%. But, again, depending on your exact tax situation, you may be subject to that extra 3.8% net investment income tax on top of your 15% or 20% capital gain rate, hence the 23.8% for taxpayers in the highest brackets. Now, long-term capital gains apply to gains recognized on an asset that is held for over 12 months or to gains recognized from a capital asset that was inherited no matter how long you owned it after inheriting it. It's a nice perk that the tax code gives us.

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Number three, you pay taxes on your qualified stock dividends similar to the capital gains rates between 0 and 23.8%, again, depending on your income level. Stock dividends that are not considered qualified are subject to higher ordinary dividend rates. The only exception to this is if you own, let's say, a municipal bond, mutual fund, ETF, or something similar, those dividends are federally tax-free and may be partially state tax-free.

Number four. Suppose your capital losses exceed your personal capital gains. For example, during a given year, you sell stocks, ETFs, mutual funds, etcetera, in your account for less than what you paid for them. So you sold them at a loss and had either no gains or limited gains from other investments that you hold. In that case, the tax code limits your capital loss tax deduction on your tax return to offset your other income to only $3,000, and it allows you to carry over or carry forward any potential losses above and beyond the $3,000 to future years until they run out. And if you file married filing separately, that number is actually $1500, not $3,000.
Number five. You first offset long-term capital gains and losses before you offset short-term gains and losses.

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Number six. If you itemize deductions on your tax return, you can deduct the fair market value of appreciated stock, mutual funds, ETFs, etcetera. You decide to donate to your church or other section 501(c)(3) charity.

Number seven. If you itemize deductions on your return, you can also deduct the fair market value of the depreciated stock you donate to your church or other section 501(c)(3) charity. In other words, stocks, mutual funds, ETFs, etcetera, that you own that currently reflect a loss.

Okay. So, now that you have a general understanding of some basic tax principles for these non-retirement accounts let's dive into the six strategies to reduce your annual tax bill. The first strategy is to properly offset gains and losses. Examine your portfolio for stocks, mutual funds, ETFs, bonds, etcetera, that you want to get rid of or unload. I should actually say that it makes sense to unload, given your financial goals and plans, and make sales where you offset any of your potential short-term gains subject to that higher tax rate of up to 40.8% with long-term losses up to 23.8%.

In other words, make the high taxes disappear by offsetting them with low-taxed losses and pocket the difference. Now, you may think, well, I didn't sell anything at a short-term gain, so I have nothing to worry about. And while that may be true that you didn't recognize any short-term gains on your own, if you own mutual funds in these types of accounts, oftentimes those mutual funds generate short term gains for you via what are called capital gains distributions. This is essentially where the professional money managers that are trading the stocks inside of the mutual fund itself produce a gain, and then, by law, they have to pass that gain out to the fund investors.

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These typically show up in the final months of the year and sometimes about halfway through the year. And while it's impossible to know how much in these capital gains distributions you might incur in a given year, each of the fund companies provides estimates of what they expect to kick out, usually sometime in October or November of each year. Make sure you pay attention to that. In my opinion, if you want more control over your tax situation and you don't want to have to deal with that uncertainty, try not to own mutual funds in non-retirement accounts.

Well, Cameron, what if I already do own some of these mutual funds in my non-retirement account, and they have a ton of gains embedded in them since I bought them? How can I get rid of them without recognizing even more gains and also avoiding capital gains distributions down the road? Well, then, you're a perfect candidate to come up with a plan to reduce those holdings in a tax-efficient manner over time using a good financial plan.
Strategy number two. Properly use long-term losses. Use long-term losses to create that $3,000 deduction that's allowed to be used against your ordinary income that we discussed before. Again, you are essentially trying to use the 23.8% loss to kill a 40.8% rate of tax. Meaning that if you're in the highest tax bracket and using your long-term losses to offset long-term gains, you're only deferring 23.8% in taxes. But if, instead, you only use your long-term losses above and beyond any gains you have, you get to offset up to $3,000 of your other ordinary income each year. Remember that ordinary income and short-term capital gains are subject to higher rates. So, in the case of those in the highest brackets, you could be saving 40.8% versus 23.8%. Now, I'll admit, that is kind of a form of financial sorcery. Don't be mistaken by thinking that this only applies to those in the highest tax brackets. It does not. The same goes for those in lower tax brackets.

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In other words, you can use a 0% loss to kill a 12% tax, for example, if you are in the 12% or lower federal tax bracket. In other words, if you're in the lowest capital gains bracket, you won't owe any taxes on your capital gains. So, if you use long-term losses to offset any potential long-term gains that you have, you're wasting them. When instead, if you use long-term losses above and beyond any of those gains, you can save 12% on your other ordinary income because you'll get to offset it with that $3,000 deduction.

Strategy three. As an individual investor, avoid the wash sale loss rule. Under the wash sale rule, if you sell a stock or other security and then purchase substantially identical stock or securities within 30 days before or after the day you sell it, you don't get to recognize your loss on that sale on your tax return. Instead, the tax code makes you add the loss amount to the cost or the basis of your new stock, bond, mutual fund, etcetera.

So you sort of get a slight benefit later if and when you sell that new security. If you want to use the loss this year from selling a certain security, you'll have to sell the stock, bond, mutual fund, ETF, etcetera, and sit on your hands for more than 30 days before repurchasing a substantially identical security. Otherwise, you can avoid it by reinvesting immediately in a security that's not substantially the same.

Now, what exactly classifies as a substantially identical security? There's some murkiness there when it comes to investments in funds like mutual funds and ETFs. So, if you aren't sure, get with your professional adviser. And by the way, the wash sale rule looks at all of your accounts. So you can't sell a security at a loss in your nonretirement account and then immediately buy that same security or similar security in, let's say, your IRA. Nice try, but you still trigger the rule, and it will be disallowed.

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Strategy number four. Make use of lower tax brackets. Do you give money to your parents to assist them with their retirement or living expenses, maybe pitch in for their care? How about your adult children? If so, consider giving appreciated stock, so stock with gains, to your parents and your adult children. Why? Well, if the parents or children are in a lower tax bracket than you are, you get a bigger bang for your buck by one, giving them the stock, two, having them sell the stock, and three, then having them pay the taxes on the stock sale at their lower tax rates. You also get a similar family benefit if your parents or children hold the stock for the dividends and then pay taxes on those dividends at their lower tax rate. In addition, don't forget to consider saving on the additional 3.8% net investment income tax if that is something that you're subject to.

So again, if they are not subject to that because of their income, then that will also be additional savings. This is all opposed to you selling the securities and recognizing any gains and also falling into a myriad of tax traps, such as more taxation on your Social Security benefits, Medicare premium surcharges, the net investment income tax, and the list goes on. Then, handing them the cash. Instead, put the tax burden on them if it's more preferential.

Strategy number five. Donate appreciated stock to charity. If you're charitably inclined and you itemize your deductions on your tax return, consider giving appreciated stock rather than cash because a donation of appreciated stock gives you more tax benefits. It works like this. Benefit number one: you deduct the fair market value of the stock as a charitable donation. And benefit number two: you don't pay any of the taxes that you would have had to pay if you sold the stock.

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Here's an example. You bought a publicly traded stock for $1,000, and now it's worth $11,000. If you give it to a 501(c)(3) charity, here's what happens. One, you get a tax deduction for $11,000, again, if you itemize on your return, and two, you paid no taxes on the $10,000 profit.

Now, there are three rules to know here. Number one is your deductions for donating appreciated stocks to your church, and other 501(c)(3) organizations may not exceed 30% of your adjusted gross income under the current tax law. Number two, if your publicly traded stock donation exceeds 30%, it's not that big of an issue. Tax law allows you to carry forward the excess until used up for up to 5 years. And number three, you get these benefits, as I said, only if you itemize your deductions.

Moving on to our final strategy, number six. Don't donate stock losses to charity. If you could sell a publicly traded stock at a loss, do not give that loss deduction stock to a 501(c)(3) charity. Why? Well, if you sell the stock, you have a tax loss that you can deduct. If you give the stock to a charity, you get no deduction for the embedded loss. In other words, you can just kiss that tax-reducing loss goodbye.

Here's the solution. Sell the stock first to create your tax-deductible loss, then give the charity the cash that you realized from the sale of your stock to create your deduction for the charitable contribution. Here's an example. You bought a stock for $13,000, and now it's worth $2,000. If you give the stock to a charity, here's what happens. One, you deduct $2,000, which was the value of your stock when you donated it to the charity.

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Number two, the charity receives $2,000, again, the value of the stock. And number three, you kiss your $11,000 tax-deductible loss goodbye. So instead, do this. Sell the stock, collect the $2,000 in cash from the sale of the stock, give the $2,000 to the charity, then deduct the $2,000 charitable donation, and you deduct your $11,000 stock loss.

Now, I want you to know whether you do this right or wrong, the charity gets the $2,000. But with the second strategy, selling the stock at a loss and then donating the cash, you get your rightful $11,000 additional tax deduction.

That does it for our six year-end strategies to reduce taxes with your non-retirement investments. And there may certainly be more opportunities given your exact situation, so always be sure to consult your professional before acting on any particular strategy or action.

And if you find the strategies I provided in today's show actionable, valuable, and insightful, please subscribe to or follow the show on your podcast app. And be sure to check out the Retired-ish newsletter as well, which is now in video format, to get more useful information on retirement planning, investments, and taxes once a month straight to your inbox. Just watch or listen. You don't even need to read it. Of course, if you want to learn more about the topics I went over in the show today or you want to ask a question to be answered on a future episode, you can find the links to the resources we have provided in the show notes right there on your podcast app, or you can always head over to retiredishpodcast.com/57.

Thanks for tuning in and following along. See you next time on Retired-ish.

Disclosure [00:21:28]:
Securities and advisory services are offered through LPL Financial, a registered investment adviser, member FINRA SIPC. The opinions voiced in this podcast are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which strategies or investments may be suitable for you, consult the appropriate qualified professional prior to making a decision.

This information is not intended to be a substitute for specific individualized tax advice. We suggest that you discuss your specific tax issues with a qualified tax adviser.

Neither LPL Financial nor its registered representatives offer tax or legal advice. Always consult a qualified tax adviser for information as to how taxes may affect your particular situation.

Tax and accounting related services offered through Plan-It Business Services DBA Planable Wealth. Plan-It Business Services is a separate legal entity and not affiliated with LPL Financial. LPL Financial does not offer tax advice or tax and accounting related services.