It’s tax season. If we didn’t know it before, we know now by all of the commercials offering to help us spend our tax refund. So, let’s talk taxes.
First, a twist on thinking about taking distributions from tax-advantaged retirement accounts.
Many of us try to sit out taking distributions from our tax-advantaged retirement accounts until we have to because, well, the money is taxable when distributed.
However, the currently ‘low’ tax brackets are due to expire in 2026.
Through the end of next year, the tax brackets are at 10%, 12%, 22%, 24%, 32%, 35% and 37%.
In 2026, the brackets are planned to revert to the pre-2018 levels of 10%, 15%, 25%, 28%, 33%, 35% and 39.6%.
Looking at these higher future tax levels, might it make sense to take some withdrawals sooner rather than waiting until you have to take them as RMDs?
(This applies only to those age 59 ½ or older. Before that, a penalty applies to taking early withdrawals from retirement accounts.)
The money taken early can be used to reduce your future cost of living by paying off debt or it can be used just to enjoy life.
Another way to take advantage of the current rates is to convert from a traditional IRA to a Roth IRA. While you pay taxes on the amount converted, the advantage here is that any future growth and distributions are tax free. You do not have to be over age 59 ½ to do a Roth conversion.
The ideas above can reduce your lifetime tax bill, i.e., paying taxes now at a lower rate to reduce your bill later on. This type of tax management means that your total tax bill over your retirement lifetime will be lower.
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Have you ever wondered why you have capital gains in your investment account when you didn’t sell anything? Well, if you hold mutual funds, you’ll have capital gains distributions even if you do not transact in your account.
What is a Capital Gains Distribution (GCD)? Investopedia defines it as a payment by a mutual fund or an exchange traded fund (ETF) of a portion of the proceeds from the fund’s sales of stocks and other assets from within its portfolio. There have to be sales within the fund during the year in order for CGDs to be generated. The CGD is the investor’s prorated share of the proceeds from the fund’s transactions. Mutual Funds are required by law to regularly – at least yearly - distribute capital gains to shareholders.
The capital gains distributions are taxable in the year they are paid unless the fund is held in a tax-advantaged account. The positive is that CGDs from mutual funds and ETFs are always taxed at long-term capital gains rates, no matter how long the investor has held the fund. This is different from when you sell your shares in the fund. Whether the capital gains are long-term or short-term depends on how long you have owned your shares. If you have held your shares in the fund for one year or less, your gains will be taxed at the regular ordinary income rates.
In order to maximize the growth of your investment, it is advisable to reinvest the CGDs in the fund rather than have them paid out to you.
When any type of distribution from a mutual fund is reinvested, the amount paid increases the cost basis on that account. So, when shares are finally sold, the cost basis reported can be much higher than the original amount paid in. The Investment Companies, e.g., Fidelity and Vanguard will report the increased basis in their tax statements.
Why can you have CGDs when the markets were down? A fund can still generate a capital gain on a security even when the overall market is in a slump or even when that fund has had a negative return for the year. This could happen when, for example, the fund has held onto the stock for a long time and it has appreciated quite a bit from when it was first purchased.
Capital gains are a sign of successful investing. It means that you have made money in your portfolio. Capital gains have been given a more favorable tax rate as a means to increase investment and thus, economic growth. As you can see in the table below, the top capital tax gains tax rate is 20% vs. a top ordinary income rate of 37%.
Capital Gains Tax Rates for 2023
Tax-Filing Status |
0% Tax Rate |
15% Tax Rate |
20% Tax Rate |
Single |
$0 to $44,625 |
$44,626 to $492,300 |
$492,301 or more |
Married, filing jointly |
$0 to $89,250 |
$89,251 to $553,850 |
$553,851 or more |
Married, filing separately |
$0 to $44,625 |
$44,626 to $276,900 |
$276,901 or more |
Head of household |
$0 to $59,750 |
$59,751 to $523,050 |
$523,051 or more |
Multiyear tax planning together with knowing where to invest can be too difficult to go-it-alone. It calls for professional advice.
Please feel free to call (215-836-4880) or email the office (ellend@regardingyourmoney.com) to set up an appointment to discuss any investment questions you may have. Or, visit us at regardingyourmoney.com.
To read more about surviving tax season, please see https://www.regardingyourmoney.com/HOT-TOPIC-Tax-Season-News-and-Survival-Tips.c10191.htm on our site.
Sources: CNBC, Investopedia , Morningstar, Weitz Investment Management