6 Ways to Navigate Capital Gains Taxes

We recently explored the topic of mutual fund fees and how much they can cut into your investment gains.
capital-gains
But fees are not the only way you pay for your smart investment calls. You also pay capital gains taxes.
Some might even regard capital gains taxes as the ugly twin sister of fund fees. Both are effectively costs that come off the top of your net investment gains. And both are realities that make those net gains look a little less sweet. It’s easy to calculate your projected retirement income based on an annual growth rate of 6% or 7% . . .  but if you are fortunate enough to realize those gains, you will be taxed.
And this week, there’s a lot of talk about capital gains taxes going up. What could that mean for an investor who has put most of his or her retirement savings in the stock market? Here are some suggestions for navigating the somewhat uncertain world of capital gains taxes:

  1. Understand that you probably can’t avoid taxes. Yes, we all have different write-offs and deductions and loopholes that may help us lower our tax bills, but as we’re being reminded this year with talk of a tax hike, these are not things we should count on. Rules change, but taxes —  in one form or another —  are a constant. Bottom line: If you are hoping and expecting to make money from your investments, expect to pay some taxes on those gains … just like you’ll invariably pay some fees from gains made on mutual funds. This may not be the cleverest piece of advice for someone who focuses on maximizing his or her retirement income, but it’s a truth that bears repeating from the outset. Nothing in life is ever totally free and that includes capital gains.
  2. Consider these taxes in the context of your overall, effective tax rate. Now that we’ve gotten the reality and inevitability of taxes out of the way, there’s some good news. At most income levels, capital gains are taxed at a lower rate than ordinary income. It’s important to understand the rate at which your investment gains will be taxed, but to also look at the big picture and remember that for most people, capital gains will not be the source of the bulk of your tax load.
  3. Unless you are a high earner, rest easy. Current capital gains taxes surpass 15% only for those in the highest income group and any future increase would probably focus on high earners as well. The majority of investors can expect to see little or no change.
  4. Seek to offset gains. Here’s one simple thing that you may be able to do to minimize your capital gains taxes: In years where gains from some investments are significant, consider unloading some of your losing holdings to offset the gains. No one wants to see any of their investments lose money, but if you do have a lemon in your portfolio, try to see the silver lining, and sell it at a time when the loss will help your overall tax bill.
  5. Hold, don’t flip. Keep in mind that you’ll pay more taxes on capital gains of investments held for less than a year. This is key: Probably the single thing that you can do to limit your capital gains taxes is to hold your investments for more than 12 months. You’ll be taxed considerably more on so-called short-term capital gains of investments held less than a year. For tips on getting started with some good long-term investments, see some of our research on strong dividend stocks that you can buy and hold. And finally,
  6. See the value of paper gains. In other words, think carefully before selling any investment, even those you’ve held for more than a year. If you don’t need the money in the short term, and if the investment appears to be a viable one for the long term, then avoid selling it altogether. Wealth is created over time and holding onto strong investments will not only help you reach your goals, it will help limit your tax bill.

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