Broker Check


Recently, my client called me to say he wanted to withdraw $ 25,000 from his accounts. He had invested $ 300,000 each in two accounts, one a fixed annuity which had given a fixed interest of 3.5% over the last 4 years and the other a portfolio of stocks and bonds. The client needed the money right away and was not concerned about the tax implications. Secondly, as he had entrusted the money to me, he expected me to help him make the best decision. Since the fixed annuity had generated interest over the last 4 years, the entire withdrawal would be taxable (last in first out rules for non-qualified annuities), but as the market value of the portfolio of stocks and bonds had just gone below the initial investment amount due to market conditions, any withdrawal would not be taxable. Very simply, the client had no idea about tax consequences and was only interested in getting the money right away, it made sense to withdraw the money from the portfolio of stocks and bonds. By selecting the right account from which to withdraw the amount, the client being in a 28% tax bracket had saved or at least deferred taxes of $ 7000!

The above example is a simple illustration of why one should pay particular attention to his or her taxes. The tax code after all is thousands of pages long and growing! It is superfluous to say that the tax code is confusing. It is reported that even the employees of the Internal Revenue Service will not be able to give guidance or advice with regard to a plethora of tax issues. One of the most ignored or overlooked tax issues that I see is in the investment area. A typical example is someone who has a number of non qualified accounts with stocks and bonds. I ask these people if they or their advisors have done any ‘gain-loss offset’ or ‘loss harvesting” during or at the end of the year. Generally, the answer to this question is they ‘look’ at their taxes or the CPA manages the taxes and files the return. This is simply not enough. As an example, a client had a non-qualified taxable account with a particular stock that he had purchased in the ‘90s and had done remarkably well. But then he had other stocks that had gone down in value in 2008 and had an “unrealized loss” situation of about $ 15,000. The logic to sell the stock (that had done well) and offset the ensuing gain of about $ 15,000 by selling other investments and realizing a loss was compelling. Therefore, capital gains taxes on the sale of the stock that had performed well were saved. In addition, one could buy the stock (which had done well) back immediately to raise the “basis’ for that particular stock. (It should be noted that wash sale rules do not prevent this particular stock being bought immediately as it had a gain, these rules however apply to sale and buy back of investments that involve a loss) We are talking about pro-actively trying to manage taxes in the investment accounts as well as the total financial situation and not reactively after the fact.

While the examples above may seem almost too simple to understand, there are many tax traps in the tax codes. I list a few that one may want to consider in his or her planning. The list is by no means complete or comprehensive of the tax planning issues that are out there:

  1. The tax rates change every few years. One’s own income may also vary over the years. Therefore tax planning is a dynamic process that is very time sensitive. What may apply by a certain date each year may not apply beyond that date or beyond the year.
  2. Many of the tax rules will “sunset”at the end of this year. This is with particular regard to the taxation of dividends, income and estate taxes. Most people expect the tax rates to go up in 2011. It is very important to do some advance planning for the tax changes that will occur in 2011.
  3. Roth conversion opportunity starts this year, without regard to income limitations. Taxes will generally apply.
  4. If one is in a potential ‘estate-tax’ situation, pay attention to gifting opportunities (gift exclusions), which are available on an annual basis and expire at the end of each year. Many people in a potential ‘estate tax’ situation ignore these gifting opportunities.
  5. Determine the ‘basis’ of all your Investments in accounts with after-tax money (non qualified), so one can plan for tax planning opportunities in the account. Many people are not aware of the tax planning opportunities available to them as they have ignored the cost basis of their accounts
  6. Be aware of life insurance policies where ‘policy loans’ of the cash value have been made and then let to expire for non-payment of premiums. One may be hit with ‘an ‘imputed interest’ tax liability.
  7. Non-qualified or non –IRA annuities present some tax issues that one needs to be careful particularly with respect to withdrawals and transfers.
  8. For retirement income distributions, location of the assets whether they be non-qualified accounts (and its composition) or IRA accounts is a particularly important consideration

As the tax laws are complex and the nuances are many, it makes sense to consult a qualified tax or financial advisor. Lastly, it is important to evaluate one’s own situation with regard to taxes and make appropriate decisions. Ignoring the impact of taxes may be perilous to your fiscal health!

Note: The examples used in this article are for illustrative purposes only. Your results will vary. Fixed Annuities are long-term investment vehicles designed for retirement purposes. Gains from tax-deferred investments are taxable as ordinary income upon withdrawal. Guarantees are based on the claims paying ability of the issuing company. Withdrawals made prior to age 59 ½ are subject to 10 % IRS penalty and surrender charges may apply. Stock investing involves risk including loss of principal. Bonds are subject to market and interest rate risk if sold prior to maturity. Bond values will decline as interest rates rise and are subject to availability and change in price

Jay Kabad, CFP®, is President of Jaykay Wealth Advisors, Inc, a Houston-based wealth management firm. He received his Graduate degree from IIT Madras and an MBA from University of Pittsburgh, PA in 1980 and has been in business for 27 years. He can be contacted at 713-780-4575.