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Investing Specialists

Tips for Lessening the Tax Bite

Readers share their year-end tax-saving strategies.

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Many investors already know that tax considerations shouldn't be one's primary concern when making investment decisions. After all, we invest with the goal of making money, and paying taxes on those gains is the cost of succeeding in that aim, so to speak. 

That said, there are plenty of ways to maximize your portfolio's tax efficiency, which helps you hold on to more of your gains and income. In that vein, we recently asked Morningstar.com readers if they were considering any portfolio moves designed to reduce their tax burden for 2015. Some respondents, such as BoomerGuy, said they aren't planing to make any changes. "Our tax situation is what it is," this reader said.

But other readers said they were at least considering making a few year-end tax maneuvers. A few respondents, such as richardsok and Sundance, said they planned to gift some assets to family members, while other readers, such as JohnGalt87, mentioned that they are considering charitable contributions.

One of the most frequently mentioned moves was tax-loss selling; however, many of these respondents also noted the difficulty of finding good portfolio candidates to sell at a loss after a six-plus-year bull market. Some other readers said that they thought it might be a good time to convert assets from a traditional IRA to a Roth. 

Below is a summary of readers' responses. You can read the full discussion, and weigh in yourself, by clicking here.

Tax-Loss Selling
An oft-mentioned silver lining of a market rout is the opportunity for tax-loss selling in a taxable portfolio. This involves selling some holdings at a loss, which can then be used to offset capital gains, helping to reduce your overall tax bill. (For more on this, see this article.)

But after a six-plus-year bull market, good tax-loss-selling candidates may be hard to find. And in fact, many mutual funds with highly appreciated securities in their portfolios may be set to pay out hefty capital gains and income distributions, as some have in the past few years. As hoodee points out, "I'll do the usual tax-loss selling, but after all these good years it's hard to find losses to harvest in my taxable accounts." 

That said, many readers noted that they had managed to identify some worthy candidates among individual stocks in their portfolios that have declined over the past few years--in particular, energy stocks were mentioned.

"I did some tax-loss selling of energy stocks over the summer before the China swoon, and may do some more this month/next month. Not in a huge rush, but want to see how 'bad' my OEFs will pay out before making any sell decisions," said rforno.

"I already harvested capital losses on my energy holdings to use $3,000 in losses against my salary income and against capital gains," said dragonpat. "I sold some  Apple (AAPL) stock to realize the capital gains in that against some of the capital losses I already had realized from the energy stocks."

"Earlier in the year, I took some profits (long-term capital gains) and during the September downturn, took some losses on energy stocks that I was 'early' in buying," said JohnGalt87. This reader also notes that "at this point, my portfolio has gotten to a point where there's little left to sell to harvest tax losses and I have a lot of gains that will remain invested (as the stocks are ones that continue to have good or better prospects)."

Capecod said, "[I] swapped around some different closed-end funds in the rate panic downdraft a while back, taking losses to offset gains taken earlier in the year. That should suffice unless FI CEFs throw off unexpectedly large capital gains at year-end." 

Close investigation of specific shares led Texasboy to identify some mutual fund shares that could be sold for a loss, even though the overall position has gained: "My taxable account investments have shown profits. Then I realized I should review the layers and realized I had some shares of a mutual fund that were at a loss although the total fund investment wasn't. So unless there's a market move upward, I'll have a few shares to sell."

Converting Assets From a Traditional IRA to a Roth IRA
Other ways readers are maximizing the long-term tax efficiency of their portfolios is through conversions from traditional IRAs to Roth IRAs. Because the market didn't perform as well in the past quarter as it has in the past few years, IRA balances may be down a bit, and the tax hit associated with converting is lower than it might have been a year ago. So, in essence, the third-quarter pullback may have presented a opportunity to reduce the taxes on a conversion that an investor wanted to do anyway. 

The key benefit of converting traditional IRAs to Roth IRAs is that it can ultimately help reduce taxes in retirement because withdrawals are tax-free. In addition, assets held in Roth accounts are not subject to required minimum distributions. (For more on this, see this article.)

"I start thinking of year-end when the second half starts. So, in August and September, when the market sold off, I did most of my Roth conversions and tax swaps. If additional opportunities present themselves by the year-end, I will do some more of the same," said yogibearbull.

Retiredgary said: "We are retired but not old enough to have to take RMDs. So we plan to do some Roth conversions before the end of the year to take advantage of our present low tax bracket."

"I have been harvesting capital losses and converting a portion of my traditional IRA, within the 15% tax bracket, to Roth," Reti59 said. "[I] hope to do this each year to eventually close out the traditional IRA before age 70."

"I have a traditional IRA and a Roth IRA. My idea is to convert $10,000 to the Roth and contribute $6,500 to a fully deductable spousal traditional IRA for 2015. I hope to come out at least even with the taxman in the short run. If it works this year, I'll do it again over several years until much of my traditional IRA is converted," said lionsgate.

"[I'm] still waiting to get a better handle on capital gains distributions in my taxable funds before attempting any Roth conversions from the traditional IRA. There may be too much taxable gain to allow more income. I try to convert as much as feasible each year, as I am in the window before Social Security and RMDs," said hoodee, who added: "If the market tanks in December, I may have more opportunity."

 

Karen Wallace does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.