Member, The Garrett Planning Network, Inc. (GPN), a Nationwide Network of Fee-Only Advisors - Hourly, As-Needed Financial Planning and Advice for Everyday Life... The New Choice for Smart Consumers (tm)
Member, The National Association of Personal Financial Advisors (NAPFA) - Advancing the Practice of Fee-Only Financial Planning
The New Tax Law: Rethinking Tax-Advantaged Accounts

By Sherrill St. Germain
This article was originally published in “Insight,” the newsletter of Lumbard Investment Counseling of Hollis, NH.

With the passage of the new tax law on May 28, investors have been asking: “How do I take best advantage of the tax cuts to help me reach my retirement, college funding, and other goals?”

First, the facts:

  • The tax rate on long-term capital gains has been reduced from 20% to 15% for taxpayers in the top 4 brackets. It is just 5% (0% in 2008!) for those in the two lowest brackets. Note: These rates do not apply to gains on the sale of collectibles, or to unrecaptured Section 1250 gain.
  • For taxpayers who favor dividend-paying stocks (other than REITs and some foreign companies), the news is even better. Previously taxed as ordinary income (maximum rate 35%), dividends on shares meeting the required holding period are now taxed at long-term capital gains rates.
  • The rates expire in 2008 unless Congress extends them.

So should investors abandon 401Ks, IRAs, 529s, etc., in favor of less restrictive taxable accounts, now that the cost of doing so is substantially lower? It depends. Investors close to retirement might be better off paying 15% on earnings from taxable accounts now (vs. up to 35% on retirement plan distributions a few years out) and preserving the option to harvest capital losses. For younger investors, especially those with employer matching, the benefits of tax deferral over many years should more than compensate for higher rates at distribution time.

With their federal and (usually) state income tax-free treatment of earnings and high contribution limits, Section 529 plans remain an important college savings vehicle. For more flexibility of investment choices and use of the money, use a Roth IRA as well, if eligible. Also, if you’ll be selling assets to pay college bills, consider gifting the assets to a child who qualifies for the 5% capital gains rate. (Watch gift tax and college financial aid eligibility!) With rates unlikely to ever be lower, this might be a great time to sell long-held assets regardless.

No matter what choices you make, you’ll want to place “tax-inefficient” investments such as REITS and high-yield bonds into tax-advantaged accounts. Assets which qualify for the lower rates (such as common stocks) should be held in taxable accounts.

With all of its nuances, limitations, and interdependencies, income tax planning is usually best addressed on a case-by-case basis. Today, the difficulties are magnified by the enormous uncertainty about future tax rates; 5 years from now, 10 years from now, and far beyond. As with investing, a bit of diversification – i.e. using a combination of tax-advantaged and taxable accounts – can mitigate the impact of an unfavorable tax change.

With apologies to Ben Franklin, nothing is certain except death and taxes… and, as recent history has shown, changes to the tax code.

back to top



home | about us | services | resources | contact
forms | FAQ | disclosure
Site design by Scribble Graphics | Site programming by SourceHosting.Net, LLC | Site hosting by Dynamic Internet
Send mail to with questions or comments about this web site.
Copyright © 2003 New Means Financial Planning. All Rights Reserved.