Portfolios Need to Adapt

Linda P. Erickson, CFP^®, is the president of Erickson Advisors and a registered principal offering securities through Cetera Advisor Networks, LLC, 336-274-9403 lindae@ericksonadvisors.net.

For many investors your investment plan requires no change, but for some investors, however, it’s important to assess how you will be impacted by the changes that go into effect in 2013.

All taxpayers with an income over $250,000 will pay an additional 3.8 percent surtax on net investment income. Does this affect you?

Let’s take a look.

What is “taxable investment income”?

Defined broadly it is: interest, dividends, royalties, rents or other passive income, capital gains from the sale of investment property, and trading of financial instruments.1 Whew!

What is NOT included?

This, too, is a long list: active business income, distributions from an IRA or Retirement Plan, Municipal Bond interest, tax-deferred non-IRA annuities, and any income subject to self-employment tax.¹

So, what can we do to get ready for this new tax environment?

Give increased consideration to municipal bond interest. As tax rates generally may rise, the effective equivalent rate on these bonds will be more attractive, and the interest will remain non-taxable.

Hold your dividend paying stock portfolio in your IRA, not your taxable investment account. Move your Individual or Trust assets into more tax efficient strategies. A professional manager may offer some help here as you balance investment and tax considerations.

Consider investing in fixed annuities and insurance investment products that offer tax deferral on unwithdrawn increases in cash value. In a rising tax environment, this tax deferral feature becomes increasingly valuable. When withdrawn, these distributions are taxed at your ordinary income rate.

Convert all or part of your Traditional IRA to a Roth IRA. While the amount of the conversion is taxed as ordinary income, it will be taxed this year at what may be the lowest rate we will see for a while. Further, once in the Roth IRA your portfolio grows tax free and all distributions are also tax free. There are no Required Minimum Distributions from a Roth IRA, and if you leave this account to your children or grandchildren, they also inherit this account income tax free. For this reason the Roth IRA is becoming a very attractive wealth transfer option.

As with all investment decisions that involve the tax code, consult with your tax advisor and your financial planner to assess the tax implications of your investment plan before taking any action.

¹ bakertilly.com. The New Medicare Surtax. August 6, 2012