Hot Topic: Tax Tips for 2013


New tax provisions from the fiscal cliff affect tax rates, investment taxes, payroll taxes, tax breaks, deductions, etc.  What tips should investors keep in mind this year?


Rick FerriRick Ferri  |  2013 Taxes and Your Investments

The recent tax law changes will crimp investment results but not enough to change how you should invest. Even if you're in the highest tax bracket, the changes are not large enough to justify a meaningful change in strategy.

On January 2, 2013, President Obama signed the American Taxpayer Relief Act of 2012 into law. The effect this act will have on your taxable investments depends on your taxable income level.

Higher long-term capital gain and divided taxes begin at $200,000 taxable income for a single filer or $250,000 for a joint filer. The rate goes from 15% to 20%.

If you have taxable income more than $400,000 (single) or $450,000 (married filing jointly), your tax bracket will go up to 39.6% from 35% for all amounts over those thresholds. In addition, the Affordable Care Act signed into law will slap another 3.8% tax on dividends and interest at these income levels. This new levy is known as the Medicare surtax.

The 3.8% Medicare surtax does not include income from municipal bond interest. Therefore, if you're in the highest tax bracket, a low-cost municipal bonds mutual fund could be a great way to add diversification and increase your after-tax return.

Investors should also consider low-turnover investments such as index funds and exchange-traded funds (ETFs). These products generally have lower capital gain distributions, lower fees, and higher returns than traditional actively-managed funds that try to beat the markets.

ETFs tend to be extra tax-efficient because of the way securities are added and deducted from those funds.  The share “creation” and “redemption” process feature offers a unique tax benefit because it results in lower capital gain distributions from ETFs than traditional mutual funds, if any at all.

High-income taxpayers might also look at the type of accounts their investments are held in. These tax-location strategies have not changed with the new tax law, but they do warrant another look.

Tax-sheltered accounts, such as IRAs, Roth IRAs, or 401(k)s, might be good places for investments that produce a large amount of income that is taxed at an ordinary rate, such as corporate bonds and real estate investment trusts (REITs).

In contrast, stocks and stock funds may make sense in your taxable account because capital gains and dividends are still taxed at a lower rate. Review your options with a qualified financial adviser.

One strategy to reduce taxes in your account may be to gift your money to someone else. The gift and estate tax and generation-skipping transfer tax exclusion amounts have been permanently increased to $5,000,000 and then adjusted for inflation annually. Talk with an estate planning expert before proceeding.

In summary, 2013 tax changes are not large enough to warrant extensive changes in an investment policy. Municipal bonds may be more attractive, tax location strategies may have become more important, and perhaps gifting to reduce your tax burden may make sense. In the end, invest we must, and there is no hiding from the tax man!


> Browse Tax Central for tax software, tax forms, shredders, external hard drives, and other supplies you need to file your taxes quickly, accurately, and safely.


Eric NelsonEric Nelson  |  5 Tax Tips To Keep More of Your Money

Avoid Active Management

Research on the benefits of “active” management is grim: professional managers as a whole are unable to match the return on a comparable index fund after fees, and investors who try to "time the market" wind up doing much worse than they would by sticking with a strategic asset allocation through thick and thin.  But the news is now worse for active investors—higher income taxes mean that an even greater share of any gains generated from short-term trades must now be shared with Uncle Sam.  Strategic "buy and hold" investing is the obvious approach for tax-sensitive portfolios.

Stick with Stocks and Bonds

Higher-yielding stocks and bonds have attracted significant assets recently due to historically low interest rates and the lingering effects of the 2008 bear market.  But falling yields combined with higher taxes on income and dividends make these strategies a poor substitute for traditional stocks and bonds.  Investors are better off building a diversified equity portfolio to include US and foreign stocks spread across large, small, growth and value companies instead of just emphasizing yield.  To reduce the risk of stocks, portfolios should use only the highest-quality bonds.  Safer bonds have lower yields and expected returns, but are expected to perform best during the inevitable periods when stocks decline.  A diversified stock portfolio combined with the highest-quality bonds offers higher expected returns, better tax efficiency than high-yielding strategies, and can be tailored for any portfolio objectives and constraints.

Earn More With Index Funds

Index Funds and Exchange Traded Funds (ETFs) are ideal holdings for investors due to their low costs, broad diversification, and style consistency.  They are even more advantageous for tax-sensitive investors when compared with actively managed mutual fund and individual security portfolios that regularly realize both short and long-term capital gains.  Investors should implement their asset allocations using only the best Index Funds or ETFs for their circumstances.

Location, Location, Location

As a general rule, investors should seek to hold their interest-bearing bond investments in IRAs.  Doing so allows them to take advantage of tax deferral and the higher yields on taxable bonds relative to tax-exempt municipal securities.  Because stock portfolios (especially those utilizing index funds) are more tax-efficient than bonds, they are better suited for taxable accounts.  When tax-deferred accounts are too small to hold the full allotment of bonds, higher income-tax paying investors will want to consider tax-free municipal bonds in taxable accounts along with stocks.  "Bonds in IRAs and equities in taxable accounts" work best for most investors.

Consider Your Cash Flows

All investment portfolios must be updated periodically.  But “rebalancing” an allocation results in taxable distributions on gains.  To reduce these costs, accumulators should "rebalance with cash flows" by directing new contributions to the asset classes that are most "underweighted" relative to their target, keeping the portfolio more consistently closer to plan.  Retirees who require ongoing portfolio income can also "rebalance with cash flows" by selling appreciated asset classes that are most "overweighed" relative to their target to generate withdrawals.  This preemptive pruning of the portfolio keeps it from deviating too far from target and will usually reduce the need for larger wholesale portfolio-wide rebalancing moves


Richard (Rick) A. Ferri, CFA is the founder of Portfolio Solutions,  the low-fee investment management firm he founded in 1999, which currently manages more than $1 billion in assets.  He is the author of six investing-related books, and shares his insights as a frequent news commentator, Forbes columnist, media contributor and public speaker.  Rick holds a Master of Science degree in finance from Michigan’s Walsh College, where he has served as an adjunct professor. Prior to entering the financial industry, Rick served as a U.S. Marine Corps officer and fighter pilot before retiring from the reserves in 2001 with twenty years of service.

Eric Nelson is a CFA charterholder who has worked in the investment industry for 15 years.  He is the co-founder of Servo Wealth Management, an independent RIA in Oklahoma City, Oklahoma.  Eric has a passion for educating investors about how capital markets work and helping his clients achieve and maintain financial independence while “simplifying complexity”.   Outside of the office, Eric enjoys spending time with his family and their three dogs, he is an avid runner and a diehard Syracuse Orange college basketball and San Francisco 49ers NFL football fan.  Eric’s research and commentary on investing can be found on his website  at the “Servo Thoughts” blog and the “Factors in Focus” newsletter.



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