Avoiding the Portfolio Tax Crunch Created By Outperforming Equities

It’s been a year of strong performance for stock markets; the S&P 500 is up 27% this year, meaning that portfolios might have a heavier tilt to equities than their strategy calls for. According to the Wall Street Journal, here are some ways to potentially alleviate tax difficulties if you find yourself in a crunch at the end of the year.

For investors whose portfolios began the year with a traditional 60/40, because of equity outperformance, the stock allocations would currently be resting around 66% in an imbalance that could equate to much heavier taxation, and exposure than the portfolio strategy calls for.

One solution that helps alleviate the imbalance and works to prevent it going forward is an “auto-rebalancing” option that quite a few 401(k) and retirement plans offer. This option allows the retirement plan to rebalance itself according to the desired exposure to stocks and bonds regularly, selling and buying to bring the portfolio back into alignment on rebalancing.

When considering just the stock portion of taxable accounts, if there are investments into ETFs or stock mutual funds that are reinvesting any dividends or distributions into stocks, change them to cash payouts to allow more flexibility and reduce stock exposure. The November and December payouts could be kept as cash or transitioned into bond allocations, inflationary hedges, or other asset types that could help diversify the portfolio.

According to Morningstar, switching to look at the bond portion of a portfolio, with most bond funds down for the year, by selling bond-fund shares in taxable accounts, an investor could balance their gains and losses. This is done by also selling stocks or stock funds in equal amounts to the bond funds, thereby balancing the profits and losses. It’s important also to remember that an investor can offset up to $3,000 of regular income if the total investment losses of a portfolio outweigh the total gains, according to Melissa Labant, a tax principal at CLA LLP.

Doing so reduces exposures to stocks while also providing the opportunity to buy into more bonds if desired. To avoid penalties from the IRS “wash-sale” rule, an investor must wait 31 days before buying back into the same bonds. Otherwise, they can invest in a similar bond immediately at no penalty.

With the holiday season around the corner, it’s also possible to gift shares to charity or individuals but ensure that the stock being gifted is one that’s value has increased overall. By gifting shares directly, investors can avoid long-term capital-gains taxes that can be up to 20% and include a 3.8% additional tax if the investor is in the top tax brackets.

For more news, information, and strategy, visit the Retirement Income Channel.