3. Take your RMD at the start of the year
If you are currently taking your RMD at the end of the year and taking your monthly distributions for living expenses from your taxable or Roth accounts you may be paying more tax than you need to be. Take your RMDs out at the start of the year to pay for living expenses. Once this cash is gone, look to pull from your other accounts. Depending on your charitable inclinations and tax bracket, it may make sense to gift your IRA distribution directly to a charity through a Qualified Charitable Distribution or QCD. I will discuss this in more depth in a future blog post.
4. Short term capital gains are evil. Try to only recognize long term capital gains
A few things to think about here:
- Short term capital gains are taxed at ordinary income rates, which can be as high as 43.8%. Long term capital gains rates are lower, anywhere between 0% and 23.8% depending on your tax bracket.
- Only use tax-managed or tax-aware funds in your taxable accounts. This sounds obvious, but for many it is not. These funds hardly ever distribute short term capital gains. ETFs are another good bet, as you have more control over when capital gains are recognized.
- Focus on buying and holding assets that accumulate unrealized gains. At your death, these assets will receive a step-up in basis. This means that your heirs will not have to pay tax on the sale, as the basis will be stepped up to current market value at date of death. Say you bought Apple stock in 1997 and it is now up 27,000%. If you hold the stock until your passing (assuming you do not need it for cash flow), your heirs can sell it without paying tax on any of the gains.
5. Have an Investment Policy Statement
Most people just have a collection of investments and no real investment plan. An Investment Policy Statement (IPS) is a written investment plan that outlines your allocation to stocks, bonds, and real estate. It provides target holdings within each asset class, and sets rebalancing parameters. It lays out in plain English how the portfolio will be managed, and outlines the risk & return characteristics that have historically impacted this portfolio (worst annual return, maximum 12-month drawdown, growth of $1, etc.) This helps take some of the emotion out of investing, as it is something you can refer back to during the inevitable ups and downs of the market. Just like putting your goals, fitness plan, or diet plan down in writing increases the likelihood you accomplish them, putting your investment plan in writing does the same. You learn that you are supposed to buy low and sell high, but most people do the opposite. They buy high and sell low, and repeat this process until they’re broke. An IPS should help in this regard.
6. Strategically spend from taxable and Roth accounts
You have already incorporated the income streams into your monthly budget that you more or less have little control over (RMD, pension, social security, rent). Now the remainder needs to come from your taxable, Roth, or tax-deferred accounts. The idea here is to limit the tax bite that may present itself. Two things:
- Be conscientious of the tax bracket you are in.
- Focus on selling assets with a high tax basis. In other words, the asset that will recognize the lowest long-term capital gains should be sold first, as long as you are mindful of the rebalance parameters set forth in your IPS.
