Investments Best Held in an IRA

The following is an excerpt from 10 Investments You Should Hold in an IRA

Whether you want him to be or not, Uncle Sam is one of your most important partners in your retirement planning. The taxes you pay have a major impact on your effective returns … and in some cases might make the difference between retiring comfortably or just barely getting by. That’s why it pays to know what investments should go in different retirement vehicles, such as a 401k, IRA or Roth IRA.

Not all investment gains are taxed equally. Some are taxed at preferential rates — or allowed to defer taxes indefinitely — while others will cost you so much of your current income, you might mistake them for a vindictive ex-wife.

So, as important as asset allocation, it’s all for naught if you don’t take tax allocation into account.

If you’re like most Americans, your retirement savings are a mixture of tax-deferred IRA and 401k money, and good, old-fashioned taxable bank and brokerage accounts. Today, we’re going talk about how best to arrange your investments within those types of accounts in order to lower your tax bill.

Obviously, non-interest-bearing cash generates no taxable income and should therefore be held in a taxable account. The same holds true for low-turnover, buy-and-hold stock index funds. There’s no reason to burn valuable tax-free dollars on something that’s not going to generate taxable gains.

Your IRA dollars should be reserved for the highly taxed stuff. So with no further ado, here are 10 investments you should always try to hold in an IRA if possible.

Alternative Investments

“Alternative investments” is something of a blanket term that can mean different things to different people.

To me, an alternative is anything other than the traditional asset classes of stocks, bonds or cash. But for many of my high-net-worth clients, this will generally mean hedge funds.

Due to the lousy yields on offer in the bond market, I’ve been using market-neutral hedge funds for accredited-investor clients. While volatility tends to be low, this usually comes at the cost of higher portfolio turnover, which is extremely tax-inefficient.

That makes them an obvious choice for an IRA.

You really should do your homework here, however, because certain assets can create tax headaches. Some funds generate unrelated business taxable income (UBTI), which can result in you having to file a tax return on behalf of your IRA. However, you can sometimes avoid this by buying the offshore version of the fund for your IRA.

Before you do this, make sure you discuss this with your financial adviser or with the fund’s general partner because every scenario is a little different. But as a general rule, a fund that is “tax safe” for an offshore investor will also be “tax safe” for a rollover IRA investor.

To finish reading, see 10 Investments You Should Hold in an IRA

Last-Minute Tax Tips Before April 15

We’re down to the last few weeks before April 15, the day more commonly known as “tax day,” among a few other colorful descriptions that are best not printed.

If you haven’t filed your tax return yet, chances are good that you’re not expecting a big refund. But it’s not too late to do a little last minute tax planning, and you might be surprised by how much a few tax tips can lower your tax bill or — hope springs eternal — actually secure a decent-sized refund.

Let’s take a look at some tax tips that can keep a little more cash in your pocket this April:

Contribute to an IRA or HSA Plan

I’ll start with one that is tried and true—contributing to an IRA or HSA plan.

For tax year 2013, you can contribute $5,500 to an IRA or Roth IRA and $6,500 to either if you are age 50 or older. The Roth IRA, as a general rule, is a better long-term financial planning vehicle. But if you’re looking to take a dent out of your tax bill today, you’ll want to contribute to a traditional IRA, as the Roth offers no tax break in the year of the contribution.

How much can you save by making a contribution? It depends on your tax bracket, but let’s consider an example. If you’re filing as a married couple with a combined income between $72,501 and $146,400, you fall in the 25% marginal tax bracket. Contributing $5,500 will mean $1,375 in tax savings. Contributing a combined $11,000 will save you $2,750.

The same goes for Health Savings Account (HSA) contributions. If you buy your own health insurance and it is HSA-compatible, an HSA can be thought of as something like a “spillover” retirement account if you have already maxed out your IRA or 401k. And unlike IRAs — in which your ability to take a deduction can be phased out or eliminated if you already contribute to an employer 401k plan — HSA accounts have so such conditions.

In 2013, an individual policyholder can contribute a maximum of $3,250 to an HSA, and a family can contribute $6,450.

Though hardly a revolutionary idea, parking cash in an IRA or HSA is a last-minute tax tip that works.

Investment Advisor Fees

Next on the list are investment advisor fees.  If you manage your own investments exclusively, then there isn’t much you can do here.  And if you use the services of a broker who charges a sales commission on the stocks or mutual funds you buy, those are not deductible (though they do affect your cost basis and thus have an effect on any capital gains taxes you pay down the road).

If you use a fee-based advisor, however, you might be in luck. Advisory fees paid to your financial advisor are indeed deductible.

There are a couple things to keep in mind though. In order to write off any investment advisory fees, you have to itemize.  Often, if you have a home mortgage, you will pay enough in mortgage interest and other home-related expenses to surpass the standard deduction.  In 2013, that amounts to $6,100 for an individual or $12,200 for a couple filing jointly. Additionally, your deductions here are generally limited to the amount of expenses over and above 2% of your adjusted gross income.

One major word of caution.  While the deductibility of investment advisor fees is unquestionably deductible for taxable accounts, it gets a little murky with IRA accounts.  Paying your investment advisor out of your IRA is not considered a taxable distribution.  But you can’t claim the fees paid as a deduction.  You can, however, claim the deduction if you pay your fees with outside money.  In practice, this will mean either writing your advisor a check or having them deduct the fees for managing your IRA from a separate, taxable account.

If you subscribe to paid financial newsletters, newspapers, or magazines, these too can be considered “investment related expenses” as well if you can credibly say that you use the publications to generate investment income.

This won’t be a large deduction for most people.   Most subscription services cost, at most, a couple hundred dollars.  Still, there is no reason not to take advantage of the tax break if these are expenses you were going to make anyway.  And for some avid investors with subscriptions to multiple publications and high-end advisory services, the deduction could conceivably be worth a couple thousand dollars.

Keep good records of your subscription purchases because, as a general rule, large itemized deductions make great audit targets for the IRS.  And naturally, you should use common sense here.  If you don’t feel you  can credibly explain to an IRS auditor that you need a given publication—such as your Sunday newspaper—to make investment decisions, you should err on the side of caution and leave those expenses off your tax return.

Child Care Expenses

Next on this list of tax tips are child care expenses. If you have kids and you pay for daycare, mother’s day out or for the services of a nanny, tally up what you paid in 2013. It could give you a nice tax credit.

The Child and Dependent Care Credit can seem a little complicated at first, but I can sum it up like this. If you pay for childcare expenses so you can work outside the home, $3,000 in expenses for the first child (or a total of $6,000 in expenses for two or more children) can be used to calculate the credit. The $3,000 (or $6,000) is multiplied by a factor that varies by income. For example, if your household’s adjusted gross income is more than $43,000, the factor is 0.2. (Don’t worry, popular tax programs such as TurboTax will make these calculations for you.) The factor is greater the less your income is, meaning that lower-income families get a larger credit.

So, for a family with two or more dependent kids, the tax credit would be calculated as $6,000 * 0.2 = $1,200.

It’s not uncommon for parents to pay tens of thousands of dollars in child care expense, so it can be frustrating that the amount used in the credit calculation is capped at $6,000. Still, a $1,200 reduction in your tax bill is nothing to laugh off, particularly considering that you were going to be making these expenses anyway.

A few things to note: To qualify, your kids must be under age 13, and the expenses must legitimately be used to allow a parent to return to work. For example, if a family has a stay-at-home mom who is not gainfully employed, they would not be able to apply any preschool or early development classes to the credit.

Also, only expenses you pay for yourself are eligible for the credit. Employer-provider care actually reduces the credit, though it also reduces your taxable income. If you have any doubts, talk to your CPA.

Check for Donations

For one final last-minute tax tip, dig through your bank statements and receipts for any donations you made to charities last year. Whether it was a check you left in the offering plate on Sunday or a gift you gave to your university or the local homeless shelter, taken in total, they could amount to a good-sized deduction.

Remember: To write off any charitable contributions, you have to itemize. Often, if you have a home mortgage, you will pay enough in mortgage interest and other home-related expenses to surpass the standard deduction. In 2013, that amounts to $6,100 for an individual or $12,200 for a couple filing jointly.

It’s also important to keep good records. Larger charities will usually send you a statement at the end of the year summarizing your donations. But smaller charities often won’t, so you’ll want to keep a copy of your bank or credit card statement or a receipt.

Cash donations are pretty straightforward, as are donations of stock or other items with a listed market value. Donations of clothes or personal items can get a lot more complicated because the “value” of the items in question can be somewhat subjective. TurboTax and other mainstream tax programs will offer guidance, but as a note for the future, I recommend taking a photo of any clothes or personal items donated to keep for your records. In the event you are audited, they can add support to your estimated values.

Note: When it comes to taxes, it always pays to get a second opinion.  If you have any questions about anything discussed in this article, discuss it with your CPA. 

This article first appeared on InvestorPlace.

Charles Lewis Sizemore, CFA, is the editor of Macro Trend Investor and chief investment officer of the investment firm Sizemore Capital Management. Click here to receive his FREE weekly e-letter covering top market insights, trends, and the best stocks and ETFs to profit from today’s best global value plays. 

3 Tax Breaks the Big Guys Use

We’ve all seen the numbers. High-income earners are subject to higher marginal rates these days: 39.6% on incomes over $400,000 for single taxpayers and $450,000 on couples filing jointly on their 2013 returns. Additionally, single taxpayers with incomes over $200,000 and married couples with incomes over $250,000 are now subject to a 3.8% “surtax” on their investment-related income as part of Patient Protection and Affordable Care Act, better known as Obamacare.

Yet few wealthy taxpayers pay anything close to those percentages. Data for the past two tax years is not available yet, but in tax year 2010, the top 0.1% of taxpayers — those with incomes of more than $1.6 million per year — had effective tax rates of less than 23%. That’s far below headline top marginal rate of 35% that year.

So, how do the big boys do it?

Wealthier taxpayers will probably always have access to tax breaks that rank and file Americans will never enjoy. But today, we’re going to take a few tricks out of their playbook.

Tax Deferrals

Most Americans have access to some form of retirement plan, be it a 401k, a 403k or a 457 plan. In 2013 and 2014, the contribution limits on these sorts of plans is $17,500, or $23,000 for employees aged 50 or older.

Yet self-employed taxpayers — and most wealthy taxpayers fall into that category — can contribute significantly more. The contribution limits on two popular options — SEP-IRAs and Solo 401ks — are $51,000 in 2013 and $52,000 in 2014.

Is this something that an ordinary American can take advantage of? If you have any kind of side business or part-time contract work in addition to your regular W-2 day job, then yes.

But you have to make sure you utilize the right retirement plan option. At high income levels, SEP IRAs and Solo 401k plans offer identical tax savings. But at incomes lower than $204,000, there is a big difference. In a Solo 401k plan, you can contribute the first $51,000 you earned last year. Whereas with an SEP, your contribution is based on a formula: 25% of your compensation up to $51,000.

So, in a hypothetical case in which your side business earned exactly $51,000 in 2013, you could defer taxes on the total amount using a Solo 401k plan, but only $12,750 using an SEP IRA.

Step-Up of Cost Basis

Whenever a taxpayer dies, the cost basis of investment assets gets “stepped up” to the current market value. A wealthy investor could literally have millions — or billions — in unrealized capital gains that disappear at death, giving his or her heirs a clean tax slate. (Of course, estates larger than $5,340,000 in 2014 will be subject to the estate tax, but that is another topic for another article.)

Ordinary Americans inherit much smaller nest eggs, of course, but the same principles can be put to work with a portfolio of any size. If you are doing estate planning and have highly appreciated stock that you bought years or decades ago, consider holding on to it for the remainder of your life with the understanding that your kids or grandkids can sell it and reinvest the proceeds in a diversified portfolio.

I should give one important caveat here: Avoiding taxes should not be your primary investment consideration. If a single stock or small number of stocks makes up a disproportionately high percentage of your net worth, you might be taking too much risk. Avoiding a 15% to 20% long-term capital gains tax is great, but not if it comes at the risk of losing more than that in capital losses if the stock falls in value.

Every taxpayer will need to weigh the cost and benefit on a case-by-case basis.

Giving Gifts to Charity

Charitable giving is always going to be more beneficial to a high-income earner than to a regular American for two reasons:

  1. Most Americans take the standard deduction on their tax return, as their itemized expenses are not high enough to justify itemizing. The standard deduction in 2013 for a married couple filing jointly is $12,200.
  2. The charitable deduction reduces your tax burden at whatever your marginal tax rate is. The same $10,000 contribution will be worth $3,960 to the taxpayer in the 39.6% bracket but just $2,500 to the taxpayer in the 25% tax bracket.

Still, while this deduction is more beneficial to higher-income earners, that doesn’t mean it can’t be used to your advantage come tax time. If you like the idea of supporting a charity, church or even your old alma mater, you might as well get a tax break from it. Keep track of all cash donations you make as well as any clothes or other items you give. Cleaning out your closet of clothes you no longer wear can save you hundreds or maybe even thousands in taxes while also decluttering your house.

Regular Americans might never get to enjoy tax breaks to the extent that the wealthy do. But that’s OK. By following the same ideas, we can at least knock a few percentage points off of our effective tax rates — and every dollar saved in taxes is a dollar that can be spent on something you actually enjoy.

Charles Lewis Sizemore, CFA, is the editor of Macro Trend Investor and chief investment officer of the investment firm Sizemore Capital Management. Click here to receive his FREE weekly e-letter covering market insights, global trends, and the best stocks and ETFs to profit from today’s exciting megatrends.  This article first appeared on InvestorPlace.