Tax Tips on How to Invest in the Current Economic Climate


With the barely-missed fiscal cliff drama still in recent memory, investors are wondering what moves they should make now to maximize profits and minimize their tax bills. As part of the fiscal cliff negotiations, lawmakers increased the top income tax rate as well as the capital gain rate for 2013 and beyond. These rate increases affect tax planning for high-income and high-net-worth individuals.

“The aversion of the fiscal cliff raised the profile of taxes in the investor’s decision making. It heightens the decisions people make about their investments,” says John Sweeney of Fidelity Investments. He adds that there are many steps investors can take to shelter their investments from high taxes and to maximize growth.

Because of the increase in the capital gains rate, it would behoove investors to contribute to their retirement plans rather than buy and sell within a taxable portfolio. If you are older than age 55, you can make catch up contributions and therefore accumulate more assets for retirement. Remember, you still have a chance to make a 2012 contribution to your IRA before April 15.

Sweeney suggests that for 2013, you should consider dollar cost averaging in to your IRA. This means that instead of making one large contribution at year end, you may want to make smaller monthly contributions to play with the highs and lows of the market.

Now might also be the time to consider converting your traditional IRA to a Roth IRA. Of course, this involves paying taxes on the amount converted, but it may be worthwhile.  There are many other factors to consider, such as, your anticipated income level at retirement, how long before you retire and future tax rates. Fidelity Investments has a Roth IRA Conversion Tool that can help you determine if converting from your traditional IRA is right for you.

If you are age 70 ½, be sure to take your required minimum distribution in order to avoid penalties. Your asset manager will let you know the amount you must take. And remember, if you would rather give money to a charity and don’t have enough to itemize deductions, your charitable contribution can be made directly from your IRA to provide you with the deduction.

Other than holding investments in tax-deferred accounts, Sweeney suggests investing in the bond market.  “Muni bonds have always appealed to higher-worth investors. Sometimes it makes more sense to hold a taxable bond and pay taxes on it.” It’s a personal decision that should be made after a session with a professional regarding tax investment management.

To protect your retirement savings in the face of rising taxes and inflation, you should know how to maintain your purchasing power with a fixed income. Income is more difficult to generate in retirement years. Therefore it’s vital to make sure a significant portion of your portfolio is in equity. It’s been demonstrated that we all have a much higher expected lifetime. Food and gasoline and rent have gone up. “Equity provides the best chance to outpace inflation,” Sweeney says.

Last but not least, if you have a high tax bill for 2012, don’t sell stock to pay for it. “A lot of families still don't know they can get an investment line of credit to pay their taxes instead of selling off stock. Just this month, Bank of the West extended a $25 million line to a customer to pay a tax bill — a much better option than selling off stocks,” says Scott Cripps, Chief Fiduciary Officer and Head of Trust Services at Bank of the West. He adds, “The worse thing is to put your head in the sand.”