Top tax and investment strategies for high-net-worth families and individuals

Did you know your investments could be in a much lower capital gains tax bracket even though your taxable income is much higher? Don’t feel bad if you didn’t because I talk to many high-net-worth families and individuals who don’t realize there is an opportunity to leverage a 0% tax rate on long-term capital gains. My constant message is: “Yes, with the right planning, there are quite a few things you can do to realize tax-free earnings on your money.”

One such strategy includes harvesting capital gains, a process of intentionally selling an investment that will have a long-term capital gain in years where that gain will be not be taxed. The gain is not taxed when it occurs in a year where you are in the 0% capital gains tax bracket. This is a critical investment strategy for protecting and building wealth, and high-tech tools can help investment advisors personalize your portfolio to reflect your unique tax, risk, and values preferences.

Can you just look at the tax tables to see if you should be taking gains or losses? No, the process is more complicated than that, but the right resources can help you make a significant impact. For example, I recently demonstrated to a client how he could take advantage of the 0% tax bracket on $33,000 of capital gains with $150,000 of taxable income. The calculation involved several factors, but the process ultimately helped to simplify a complicated process and show that minor adjustments can help achieve significant goals. In this article, I’ll discuss a couple of tax and investment strategies to help you maximize your investments.

Tax-loss harvesting

Tax-loss harvesting aims to generate benefits to taxable investors with realized gains in their portfolios by roughly tracking standard benchmark indexes while realizing losses on individual stocks. These capital losses can provide benefits by offsetting gains that would otherwise trigger tax liability. This benefit derives from two sources:

1. The direct, which accumulates the taxes avoided at the time a loss is realized; AND
2. The deferred, which reflects the time value of money when direct benefits are reinvested

These two different benefits provide value at different times through the life of a loss-harvesting portfolio and across different market regimes.

Beware of the mutual fund tax trap

Because many domestic mutual funds have huge unrealized gains, high-net-worth individuals need to think twice about buying these funds even if they have 5-star ratings by Morningstar. When fund managers turn over portfolios, this can trigger large capital gain distributions, resulting in recent buyers paying taxes on capital gain distributions that were generated long before they bought the shares.

To avoid this pitfall, you have a number of options. First, you can select an exchange traded fund (ETF). Even an ETF with a long history can avoid generating capital gain distributions by “swapping” shares of one company for shares of a different company. If you prefer an actively traded strategy, you have two choices:

1. You can pick a newly created fund with fewer years of accumulated unrealized gains, managed by a person or team that has an outstanding long-term record for managing equities.
2. You can select a professional who manages individual equities.

In either case, any gains generated by the manager will be those that are earned by the client.

Timing is also important – if you buy mutual funds shortly before they pay out their capital gains (typically around the end of the year) you may also be “buying” an income tax liability.

The tax and investment strategies you should consider are numerous and often too complicated to cover in a single article. Sit down with a financial advisor to fully maximize the tax benefits and investment strategies available to you. For more information, please contact your relationship manager.