As of the time of this post, current tax law has reduced the long-term capital gains tax and the tax on qualifying dividends to 15%. However, interest income, non-qualified dividends, and short-term capital gains will still be considered ordinary income and therefore taxed as high as 35%.
In light of these changes, you may want to reevaluate which of your investments should be inside your IRA and which ones should be held in taxable accounts.
IRA tax rules consider all distributions from your IRA as ordinary income and therefore taxed as high as 35%. On the other hand, withdrawals from a taxable account might be treated at the more favorable 15% rate if they are qualifying dividends or long-term capital gains.
Based on these IRA tax rules, you could conclude that you would be better off putting bond funds in your IRA and stock funds into a taxable account. But the answer may not always be that simple.
Suppose that you own a stock fund in a taxable account, and the manager trades frequently and creates short-term gains? The gains will be passed on to you and taxed at the ordinary income rate.
Therefore, in this case, a stock fund held in a taxable account, was not tax efficient.
Would you be better off holding it in an IRA?
It’s possible; especially when you consider that the tax deferral within an IRA can enhance the compounding of the earnings. But there is another point to consider.
If the fund is held in a taxable account it will receive the step-up in basis when you die. This will eliminate any capital gains tax that your heirs would pay on your investment’s accumulated profit.
In addition, you can deduct losses within a taxable account yet cannot for an IRA.
Saving money on taxes is certainly important, but you need to take your full financial picture into consideration before making any decisions.
If you are not sure whether your investments are making the best of the current tax laws, feel free to contact us to schedule a complimentary telephone review of your current tax situation.