With markets running high, your taxable gains may be higher in 2021 than usual. Don’t panic! This is a good thing if managed properly.
Since the start of 2020 through Nov. 29, 2021, all three major U.S. market indices are up double digits. High stock markets often increase taxable gain as people buy and sell assets to balance their portfolios.
Taxable gain is a profit that results from the sale of any asset subject to taxation. When it comes to investments, taxable gains occur in two ways.
One is when you or your investment manager sell a security. The other is when an investment fund you are using sells a security on your behalf within the fund. You can check a mutual fund’s estimates for capital gains distributions for the year.
How gains are taxed
Keep in mind that gains are good — they are profit, after all. And the tax rate is generally lower than the rate for your “ordinary income.” Ordinary income includes pensions, the taxable portion of social security benefits, interest, etc. Because capital gains are not considered ordinary income, increased gains generally won’t push your ordinary income into a higher tax bracket.
One exception: Profit from assets that you’ve owned for less than one year is taxed as ordinary income. Consequently, these short-term gains are subject to your ordinary income tax rate and can increase your overall tax bracket.
How to manage gains
Each year, we create a “capital gains budget” for our clients, outlining our strategy for taxable capital gains recognition. Setting a budget such as this is key to enhancing investment gains while minimizing taxes paid on them.
We create the budget by first looking at what updates a portfolio will need during the year. Then we outline year-by-year when to realize gains, aiming to avoid higher capital gains rates if gains stack up. In addition to planning when to realize gains, we might also balance gains with losses, carry losses over to future years or give assets to heirs or charitable organizations to reduce tax liability.
If you have any questions about your likely 2021 taxable gains or your capital gains budget, please speak with your wealth manger.
Laura is a Senior Wealth Manager and the Founder of LWP. She has a master’s degree in tax and is an excellent listener. While she is a sophisticated financial planner with experience in complex issues, her priority is ensuring a financial plan works for people.