Hello everyone and welcome to this month’s Ask the CFP segment. This month’s question is, “How can I avoid the Net Investment Income Tax?” For those not familiar with this tax, the Net Investment Income Tax is assessed on net investment income from capital gains, dividends, taxable interest, certain rents and royalties and certain non-qualified annuity payments. Essentially, it’s triggered by passive investment activity instead of earned income. However, it doesn’t apply to everyone. The tax applies when someone has net investment income and their modified adjusted gross income is over $200,000 for individuals and $250,000 for married couples filing jointly. The tax originated in 2012 to help pay for Medicare costs.
If this tax applies to you, it may be difficult to completely avoid it, but here are four ideas on how you may be able to reduce it. First, since the tax doesn’t apply to incomes under the levels mentioned earlier, reducing your modified adjusted gross income may be the ideal strategy. Timeless strategies such as tax loss harvesting, tax deferral and donating appreciated stock to charity may be enough to reduce income below this limit. Donating appreciated stock in particular can be a valuable strategy with both an income tax deduction and avoiding long-term capital gains taxes.
Second, if you own bonds in a non-qualified investment account, consider using municipal bonds. Muni bonds are generally tax-exempt at the Federal level and may also be exempt at the state level too if you buy muni bonds from your state. Third, consider using a no-load variable annuity for a portion of your portfolio if the majority of your assets are in taxable, non-qualified accounts. You’ll generally need to wait until age 59 and a half to withdraw the funds from a variable annuity, but deferring gains into the future may allow you to better control your taxes, including the net investment income tax.
Lastly, if you have assets in both retirement accounts and taxable, non-qualified accounts, consider using the retirement accounts for investments that generate passive income, such as bonds and high dividend investments. Then more growth-oriented investments that pay little to no dividends could be held in the non-qualified accounts instead. This strategy may allow you to hold a diversified pool of investments, but in a way that’s more favorable for your tax situation. We call this asset location. Essentially, tax efficient investments would be placed in taxable accounts while tax inefficient investments that generate income would be placed in tax-deferred accounts.
Aside from these four strategies, remember that Roth IRA distributions are also exempt from the Net Investment Income Tax. As a long-term strategy, consider ways to increase your Roth assets over time. Overall, tax planning can be difficult, but various strategies do exist to manage taxes like the Net Investment Income tax. If you have a question about this topic or have a question for next month’s video, please send it to TFreeman@MonetaGroup.com. Thanks for watching and we’ll see you next month.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. Please speak with a qualified tax or legal professional before making any changes to your personal situation.
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