Over the next few months, I’m sure you’ll see a lot of stories regarding year-end tax planning. (Here’s a link to a typical story: “What Some Investors Are Doing to Anticipate a Tax Increase” by Paul Sullivan). This year, these stories should be more numerous, mainly because of the uncertainty surrounding the so-called Bush tax cuts. Unfortunately, most of the advice reported on is likely to be based on a flawed approach: they’re likely to ignore the purpose for which these taxable investments are being held, e.g., supplemental retirement savings; part of wealth transfer program; college education fund; or short term expenditures such as a wedding, home renovation, travel plans, etc.
Each broad category of savings should have its own unique strategy in the current economic environment.
Let me deal with one I’m most familiar with – supplemental retirement savings. As the founder of the Savings2Income (S2I) planning method and sponsor of the www.Savings2Income.com website, my team and I studied this area considerably to develop what we consider the best approach to saving and investing for retirement.
While S2I is primarily focused on the middle market and mass affluent investor, the strategy works for HNW investors as well. Here’s how both types of investors ought to apply the strategy as part of their 2012 year-end tax planning, as well as longer term retirement planning.
Assuming you’ve identified a portion of your non-qualified financial assets (which excludes IRAs and 401(k) plans) that are long term and needed to generate retirement income, the year-end strategy is quite clear and simple if the Bush tax cuts expire for you:
- Sell a portion of these taxable investments, realize any capital gains in 2012 at the lower capital gains tax rate, and establish a new cost basis for these net assets.
- Invest these net proceeds into a no load Variable Annuity to be used as a future source of your retirement income.
If you follow the S2I planning method for converting savings to income, this strategy can produce a dramatic increase in after tax retirement income derived mainly from lower fees and tax deferral.
Almost as important, you’ll be able to tune out on all tax and investment timing discussions on this important part of your savings. And, you’ll only pay taxes on what you withdraw (even then, some of what you withdraw is considered a return of principal, not income) and not on what you earn each year on this part of your savings.
Even if the Bush tax cuts don’t expire and/or are continued for you, it is still a good strategy to consider.