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Year-end tax considerations for investors

December 09, 2013

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In this interview, Sarah Hammer, a senior investment analyst in Vanguard Investment Strategy Group, reviews popular year-end tax strategies such as rebalancing, gain/loss realization, and charitable giving.

Equity investors have had a banner year, while bond investors ... not so much. Rebalancing may be in order for many portfolios. Are there approaches to rebalancing that can increase a portfolio's tax efficiency?

Yes. It's an important question and, yes, we've seen stocks up significantly so far this year and bonds down slightly. And generally, when we think about rebalancing, we think about three different areas. We think about taxes, time, and labor.

Sarah HammerAnd when we think about taxes, we think about utilizing your tax-advantaged registrations to rebalance your account. And then, where appropriate, using your taxable accounts to take losses to offset any gains that you may have realized in your portfolio.

And then we also think about transaction costs in terms of selling or buying in the portfolio. And then, finally, the time and labor involved in rebalancing the portfolio as well. You know, our research has shown that there's no one method, there's no one point in time when it's optimal to rebalance the portfolio. The important thing is that you'd want to have thresholds in your portfolio, perhaps around 5%, and then that you would want to rebalance regularly, annually or semiannually, for example.

You touched on asset location using different types of accounts to conduct your rebalancing. Could you provide an example?

Sure. One simple example would be if you had already realized gains this year in your portfolio, then you may want to use your taxable accounts to realize losses in the process of rebalancing the portfolio. But, for example, if you did not already have realized gains this year, then you might choose to use your tax-deferred accounts to rebalance so that you don't incur additional tax liability.

We also usually touch on realizing gains and harvesting losses this time of year. Any other points you want to make on those topics?

Sure. There's definitely something to keep in mind which is that under the new tax rules we have higher taxes this year. There's a new bracket, the 39.6% bracket for those in the very highest area of income. And then there's a new tax, the Medicare investment surtax of 3.8% of net investment income. And then, for long-term capital gains and dividends, there's also a higher rate which is 20% as opposed to 15%, and that applies to those taxpayers that are in that highest ordinary income tax bracket.

December 31So it's definitely something to keep in mind when we think about whether or not to realize gains on the year, that you're going to have to pay that higher tax rate.

Now, you may be able to take advantage of loss harvesting in your portfolio if you have realized gains and you have appropriate losses that you want to take. For example, if you're rebalancing, as we're talking about, or if you want to move from a high-cost fund to a lower cost fund, or if you have a concentrated position that you want to diversify. Loss harvesting might be appropriate in those cases. Generally speaking, we don't recommend gain harvesting because it is dependent very much on future tax rates which are really uncertain.

For investors who have begun receiving required minimum distributions, I understand there's a provision that will expire at year-end related to charitable giving. Can you describe this short-lived opportunity to reduce taxes using your RMD?

For those who are age 70½ or older, you have to take your RMD out of your IRA or any qualified retirement account, but not your Roth, and you'll have to pay tax on that amount. Now, one thing to keep in mind is that Vanguard can help clients perform the RMD calculation if they need assistance with that.

And the provision that you referred to in terms of charitable giving is called the qualified charitable distribution (QCD) provision, and it actually is only applicable at this time until December 31 of this year. And under the QCD provision, you can actually make a charitable contribution directly from your IRA to a qualified charitable organization and take advantage of that RMD. So your RMD will be fulfilled, you make your qualified charitable distribution directly to the charity, and you sort of kill two birds with one stone by doing that.

The so-called "Pease limitation" limits the value of itemized deductions. Can you share the results of your research on the effects of this change in the tax code?

Yes. Under the American Taxpayer Relief Act that was enacted at the beginning of this year, we had an additional layer of complexity added back into the code, and that's the Pease limitation on itemized deductions, and that applies to taxpayers with adjusted gross income over a threshold of $250,000 if you're a single filer, or $300,000 if you're married filing jointly. And the Pease limitation reduces the amount of your itemized deductions by 3% of the amount that your adjusted gross income exceeds those thresholds.

So it's pretty complex. But what we did here at Vanguard is some research related to how does that Pease limitation affect potential charitable gifts. What we found is that for many taxpayers who have state and local taxes or a mortgage interest deduction, the Pease limitation would be satisfied by those two things, their state and local taxes and their mortgage interest deduction.

And so, if you are charitably inclined, you could go ahead and make that gift if your limitation is already satisfied and you would receive the benefit of your charitable deduction. And the reason for that, in all of these complex rules, is that the Pease limitation is applied based on your adjusted gross income not based on the amount of your itemized deductions.

Given the ever changing landscape of taxes, this has been a very valuable conversation. Thank you so much for joining us.

Thank you for having me.



  • All investing is subject to risk, including the possible loss of the money you invest.
  • Tax-loss harvesting involves certain risks, including, among others, the risk that the new investment could perform worse than the original investment, and that transaction costs could offset the tax benefit. There may be tax implications.
  • The information provided here is for educational purposes only and isn't intended to be construed as legal or tax advice. We recommend that you consult your a tax or financial advisor about your individual situation.
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