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Strategies for Lowering Taxable Gains

Our financial consultants provide insight on understanding and managing taxable gains in investment portfolios.

07/24/2023
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Key Takeaways

Investment gains come with a tax burden, but understanding the rules can help you minimize your year-end tax bill.

A tax-loss harvesting strategy can help you reduce your tax obligation by offsetting gains with losses.

Working with financial and tax professionals can help you determine what action you can take to make your portfolio more tax efficient.

Managing investment taxes can add another layer of complexity to your financial plan. Clients frequently ask about ways to minimize annual taxable gains. There are strategies—and working with a professional can help you work through your options and opportunities.

Financial consultants Amy Alley, Chris Goodwin, Rowland Pepito and Jennifer Simmons share common tax discussions and provide insight on what to consider when you’re evaluating your investment and tax plans.

Gauging Overall Tax Awareness: Starting the Conversation

Some clients are more aware of their tax obligations and complications than others. Their knowledge might depend on how long they’ve been investing, what kinds of accounts they have (taxable vs. tax-advantaged) or how extensive their investment portfolio is.

“There’s a lot of fear of the unknown,” says Jennifer. “People have an aversion to talking about taxes, wanting to believe that they’re not going to get a surprise bill at the end of the year. The more specific we can be and apply strategies to their situation, the more they can overcome that fear.”

Clients understand that investments can come with a tax burden. But investing can be more tax efficient than they think—they have the potential to be taxed less on each dollar earned by their portfolio than on regular income because of the benefits of discounted qualified dividends and capital gains or municipal bond income. The challenge is that investments don’t offer withholding to avoid a year-end tax bill, especially as the portfolio gets larger.

To start the conversation, Rowland talks about tax efficiency in general, and then he provides examples.

“In 2022, we saw a big down quarter in the beginning of the year, so we can look at the ‘what ifs’ about the losses,” he says. “What if the investor kept track of those early losses and compared those with portfolio gains at the end of the year?” Effectively, they may have had no tax obligations because losses at the beginning may have offset later gains.

And that brings us to an often-overlooked strategy to manage taxable gains: tax-loss harvesting.

Tax-Loss Harvesting: Offsetting Taxable Gains With Losses

With this strategy, an investor intentionally sells an investment at a loss and reinvests the assets elsewhere. The goal is to offset taxable gains with those losses, thereby lowering the overall tax burden.*

Additionally, selling at a loss doesn’t necessarily have to be an investment loss—it could also be a tax loss. A client can have an account for years, have meaningful gains through the investment but actually lose money overall due to large tax payments over time.

Not for Tax-Advantaged Accounts

Tax-loss harvesting should only be used for taxable accounts, not tax-advantaged accounts like IRAs, 401(k)s and 529 education savings accounts. Capital gains, earnings and dividends for those types of accounts will not be taxed as long as they remain in the account.

According to our consultants, most of their clients don’t use the term “tax-loss harvesting.” Discussions often start by identifying pain points, and taxes on gains are often at the top of the list. Clients will then ask about tax-loss selling, offsetting or even “write-offs,” but they have the same end goal: minimizing taxes.

“We talk through methods to reduce their tax obligations,” says Amy. “We help them understand that tax-loss harvesting has the potential to be a win-win—you have a taxable gain in your fund and can still lower taxes elsewhere.”

Tax-loss harvesting is often seen as an end-of-year task, but Amy stresses that it’s important to consider the strategy as the opportunity arises. “We don’t address it every year,” she says. “But if there’s a market drop, it might be time to harvest strategic losses for the year.”

Also, when estimated distributions come out, clients can redirect capital gains distributions into something more tax efficient and not compound the problem with more shares each year.

Chris cautions that some clients can take this strategy and go overboard. “I had a client who liquidated a huge position in an attempt to capture a negligible tax loss,” he says. Tax consequences can inform your investment decisions but shouldn’t be the sole reason to make a move.

Finally, selling investments isn’t the end of the story: Reinvesting is important to avoid missing out on potential market earnings. (See the “wash sale” rules about reinvesting into the same investment.) An advisor can help you determine where to put the assets as part of your overall investment plan.

Team Effort: Working With Your Tax Advisor

Chris emphasizes that these conversations are a benefit of having a relationship with a financial consultant. “We can work together to find blind spots and opportunities,” he says.

While our consultants can talk through investment-related tax issues, they don’t provide specific tax advice. On the flip side, tax professionals understand how investments are taxed but may not know the ins and outs of your unique investment portfolio. That can make it hard for clients to know when to take action.

Getting a tax advisor on board to run the numbers can help clients feel more confident putting a tax-loss harvesting strategy into place. “We encourage them to run it by their CPA. CPAs may not be as familiar with investments, but they are a great resource to get clients comfortable with the concept,” says Chris.

Contributors

Amy Alley
Amy Alley

Financial Consultant

Financial Consultant Rowland Pepito, CFP®
Rowland Pepito, CFP®

Financial Consultant

Financial Consultant Chris Goodwin
Chris Goodwin

Financial Consultant

Financial Consultant Jennifer Simmons
Jennifer Simmons

Financial Consultant

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*

Long- and short-term capital gains are taxed at different rates. Long-term gains may only be offset by longer-term losses. Likewise, short-term gains may only be offset by short-term losses.

Investment return and principal value of security investments will fluctuate. The value at the time of redemption may be more or less than the original cost. Past performance is no guarantee of future results.

IRS Circular 230 Disclosure: American Century Companies, Inc. and its affiliates do not provide tax advice. Accordingly, any discussion of U.S. tax matters contained herein (including any attachments) is not intended or written to be used, and cannot be used, in connection with the promotion, marketing or recommendation by anyone unaffiliated with American Century Companies, Inc. of any of the matters addressed herein or for the purpose of avoiding U.S. tax-related penalties.

This information is for educational purposes only and is not intended as tax advice. Please consult your tax advisor for more detailed information or for advice regarding your individual situation.

This material has been prepared for educational purposes only. It is not intended to provide, and should not be relied upon for, investment, accounting, legal or tax advice.