4 Approaches to Enhance Your Portfolio without Additional Taxes

Investors must periodically review, re-evaluate, and revamp their investment portfolio. This is necessary because depending upon the returns offered by each asset over time, the original composition of investment changes. Subsequently, all the factors associated with the portfolio, like absorbable risk, tax liability, etc. gets modified. During these times, tactful improvisations in the portfolio can help re-establish these factors. However, changes in the portfolio to reduce risk or enhance returns might result in additional tax liabilities due to an increase in taxable capital gains. Therefore, it becomes imperative to make desired modifications without triggering additional taxes. This can primarily be done by altering individual retirement accounts (IRAs) and 401(k) accounts as these are tax-deferred instruments.

However, the changes in these accounts must be made within limits to ensure no additional tax burden. Here are four such approaches, which can be used to enhance the portfolio without incurring additional taxes:

1. Contribution to charities

It is safe for investors to make modifications in their portfolio, only if they are done within the tax-deferred accounts. However, for investors aged above 70 years and 6 months there is another option available, provided the investors have accounts which involve maintenance of minimum distributions. This option is known as qualified charitable distribution (QCD). Investors need to withdraw required minimum distributions (RMDs) out of their IRA and channel them into various selected charities. A QCD cannot be used as an option for funds from company retirement plans. The implementation of this strategy will not result in any tax increase as the taxable income remains unaffected under this approach. The same is true for RMDs withdrawn from an IRA. The RMD amount can be utilized or re-invested without any impact on taxes and the complete fulfilment of regulations of the Internal Revenue Service (IRS). The new regulations that have been introduced involve higher tax liabilities, implying that contributions to charities will not save as much tax as it used to before. This makes a QCD an even more sought-after approach as tax-saving strategies under various categories have become less beneficial. Moreover, this strategy is not only helpful in tax balancing but also the enhancement of investment portfolios. The investor does not have to withdraw all holdings. The key here is that the total amount of RMDs extracted must be correct.

2. Consolidation of charities

As explained earlier, as far as tax is concerned, the new laws are not quite favourable for an investor when it comes to contributions to charities. If investors have not yet started their RMDs, the charities are not of much use. This is because contributions to charities are a form of itemized deductions and the new tax regulations that were introduced during the 2018 taxation year, have resulted in fewer benefits from them. The new regulations can result in higher standard deductions as compared to itemized amounts.

This will be applicable in the case of the majority of the taxpayers. However, if the investor is keen on charitable contributions, then it is advisable to consolidate the charities into one year rather than contributing a small amount every year. Investors can benefit in several ways by making one consolidated contribution rather than several small contributions over many years. The benefits include the removal of tax liabilities from appreciated holdings and a reduction in problem areas in the portfolio. Investors will be required to either use donor-advised funds to make charitable contributions or directly contribute appreciated holdings to charities. This measure will most likely reduce the enhanced risk to the portfolio due to increasingly appreciated shares.

3. Remain within a no tax band

There is a separate approach that is feasible only for investors whose taxable income is within the no tax category. This approach is called tax-gain harvesting, which is specifically advantageous to those whose taxable income is at the lower end. The no-tax threshold is applicable to individual tax filing as well as joint tax filing (for married couples). These investors can utilize their low taxable income position not only to alleviate increasingly appreciated holdings but also decrease their stake in particularly problematic holdings. In addition to this, tax-gain harvesting can be done without any additional tax burdens. However, the investors have to be excessively cautious of not exceeding or crossing the no tax slab of taxable income for the individual or joint filing. This is inclusive of the capital gains made by disposing of securities. Meanwhile, this strategy is also beneficial in the context of the future. In case there is an increase in tax thresholds, the taxpayers will be free of worries because they had already safeguarded themselves against the tax burden by disposing of the appreciated shares at a time when they did not bear any tax liabilities. If the investors land up shifting their investment to different holdings in their portfolio or re-invest the amount in the same holdings, they will have to bear the burden of the new higher tax costs.

4. Reinvestment of dividends/capital gains

This strategy involves the deployment of dividends and capital gains extremely cautiously. The investor is advised not to re-invest returns into appreciated positions or in holdings that have been specifically complicated. The dividends and capital gains must, therefore, be deployed into underweight holdings. This will prevent any increase in tax burden due to appreciated holdings. In addition to this, it will be instrumental in balancing the composition of the financial portfolio.

Alleviation in the deployment of funds into stocks and holdings with growth potential will also reduce the investor’s associated risk level. These stocks are the ones that are likely to offer increased capital gains. Therefore, when dividends and capital gains are reinvested in other standard stocks, it proves to be a highly tax-efficient way to enhance the arrangement of the investor’s taxable investment portfolio.

To sum it up

While individuals must reassess the composition of their portfolio, it is equally important to understand the impact of this reassessment on tax. A portfolio’s review must be intended towards two primary goals. One is to enhance the positioning of the taxable portfolio, and the other is to make sure that the investors do not have to bear additional tax burdens due to that improvement. The important thing to note here is that not every approach is suitable for all investors. The situation and portfolio of each person require individual discretion and assessment.

The use of the above strategies to meet these goals, are highly professional and, therefore, require the assistance of an expert. You can get in touch with financial advisors to ensure a balanced portfolio without any additional burden of taxes.