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10 Tax Planning Tips for Mutual Funds

12/4/2017

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10 Tax Planning Tips for Mutual Funds
​Mutual funds benefit from the long-standing belief that they allow investors to diversify their holdings without buying individual stocks. But to the unwary investor, tax surprises abound. From a tax planning viewpoint, here are some great mutual fund tips. Most of these tips assume your mutual fund investment is not in a retirement account (like a 401(k) or traditional IRA), unless otherwise noted.

Maximize Your Mutual Fund Investments 

  1. Recordkeeping is important. Keep good records of every transaction. While brokers are now required to report your cost basis to the IRS, the information they provide may be in error. It's best to develop a digital or paper filing system to confirm the accuracy of what your broker is reporting.
  2. The IRS wants your cost basis. Know what each share of your mutual fund costs you. This cost basis includes any costs related to the transaction like brokerage fees. It can get pretty complicated as your mutual fund buys and sells shares in underlying individual equities that make up the mutual fund. It is even more complex if your mutual fund automatically reinvests any dividends.
  3. Transfers could cause a tax event. Ask you broker or agent if there will be a capital gain if you transfer mutual fund shares from one account to another. What appears to be a transfer may actually be a sale of shares in one fund and a purchase of shares in another. This can create a taxable event if not handled properly.
  4. Long-term gains create a potential tax benefit. Whenever possible, time your sales to avoid short-term capital gains (on assets held less than one year). Short-term capital gains are taxed as ordinary income, whereas long-term capital gains often have a lower tax rate.
  5. Time your sales to account for dividend distributions. If you've owned appreciated mutual fund shares for more than 12 months and want to sell, find out when your fund distributes dividends. Dividend tax rates could apply and may be very high. Selling before the dividend payout may keep all your earnings as long-term capital gains.
  6. Dividend distribution can impact the fund’s value. Similarly, if you've had your eye on a particular fund, understand the historic payout of dividends. The cost of the mutual fund might be artificially higher right before a dividend payout. To make matters worse, you may even get a dividend distribution that is taxed at higher ordinary income tax rates for gains that occurred before you purchased the mutual fund.
  7. Take advantage of tax-deferred investments. Maximize your contributions to tax-deferred plans, especially those with matching contributions from your employer.
  8. Plan withdrawals from retirement accounts to be tax-efficient. Remember withdrawals from mutual funds within retirement accounts like 401(k)s and traditional IRAs are taxed as ordinary income. Because of this you should plan for your withdrawals to be as tax-efficient as possible.
  9. Charitable gifts of mutual funds has a tax benefit. As with individual stocks, consider donating appreciated mutual fund shares instead of cash. Tax law allows you to deduct the full market value of the higher share price without having to claim a taxable gain on the appreciation of the share value.
  10. Look at mutual fund costs. Disclosure rules require fund managers to adequately display the costs associated with each mutual fund. All things being equal, consider these operating costs when deciding between similarly performing mutual funds in a category.
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When Do You Have to Withdraw from Retirement Accounts?

12/1/2017

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When Do You Have to Withdraw from Retirement Accounts?

How the Required Minimum Distribution Works

​We're always being reminded to save for retirement in tax-advantaged accounts like 401(k)s or IRAs. But did you know the government does an about-face and forces us to take money out of those accounts once we reach retirement? It's called the required minimum distribution (RMD) rule. Here are some tips you should know about RMDs well before you reach retirement age:
​
  1. RMD penalties are high. RMD rules require you to withdraw a certain amount of money every year from tax-deferred retirement plans like 401(k)s and traditional IRAs after you reach age 70½. Whether you want to or not. These withdrawals are then taxed as ordinary income. If you don't follow the rules, the IRS can assess a penalty equal to 50 percent of the amount that should have been withdrawn, on top of the regular tax due.
  2. Start thinking about RMDs early. One of the biggest mistakes retirees make is waiting until age 70½ to start thinking about RMDs. Remember, you can start withdrawing funds without penalty after you reach age 59½. If you start planning a tax-efficient withdrawal strategy before RMD rules kick in, you can manage what tax rate will be applied to your retirement distributions. With careful planning, smart taxpayers can easily reduce the federal tax rate they pay on their retirement distributions by 5 percent or more.
  3. The ½ year start date is confusing. You don't have to start taking RMDs until April 1 of the year after you turn 70½. For example, if you turned 70½ on July 15, 2017, you wouldn't have to take your first RMD until April 1, 2018. However, after that first year, RMDs will be due by Dec. 31 on every year afterward (including on Dec. 31, 2018 in this example).
  4. RMD amounts are based on complex tables. How much you're required to withdraw is based in part on the average life expectancy of someone your age. A calculation based on complex IRS life expectancy tables, plus your retirement account balance in the prior tax year, is used to determine your RMD. The good news is that the financial institution handling your retirement account will usually do the calculation for you.
  5. There are exceptions to distributions if you still work. If you reach 70½ and you’re still working for an employer providing you with a 401(k), you usually don't have to take an RMD from that account as long as you don't own 5 percent or more of the company. However, you still must take RMDs from other plans where you have assets.
  6. Not all accounts require distributions. Remember, not all retirement accounts require you to take an RMD. Roth accounts, for example, avoid RMDs and give you some extra flexibility to manage your other taxable withdrawals during retirement.
​
RMD rules can be confusing, and are a good example of why tax planning is such an important component of a retirement strategy. Please call if you have questions about any tax obligations related to your retirement accounts.
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Ellsworth & Associates, Inc. CPAs
513.272.8400
Cincinnati: 9624 Cincinnati Columbus Road, Suite 209, Cincinnati, OH 45241
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  • About
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