Capital Gains Tax Strategies: How to Protect Your Assets and Stay on Track for Retirement

<b>David Strachan, CTFA</b><br> Senior Vice President & Director of Fiduciary Services

David Strachan, CTFA
Senior Vice President & Director of Fiduciary Services

August 16, 2021

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As we enter into a new era of tax code proposals from the Biden administration, it’s important to be thinking about what those changes may mean when planning for the upcoming tax season and retirement. This is especially important for wealthy individuals, who will be affected by the capital gains tax.
 

 The proposed tax increase on capital gains would be applied to taxpayers with annualized realized gains over $1 million. 


The proposed tax increase on capital gains would be applied to taxpayers with annualized realized gains over $1 million. These high net worth individuals will have to pay a higher tax rate of 39.6%, which is almost double the current 20% rate for individual taxpayers.
 

What Biden’s announcement to make cap gains retroactive means for investors

Unlike with previous tax plans, there is a potential for a real fly in the ointment that could significantly alter how individuals protect their wealth. That’s because Congress is discussing making these changes retroactive to April 28, 2021. Although, it is important to note that Congress has historically not affected tax bills on a retroactive basis. There is a lot of negotiating still to come in a very divided Congress before any new tax proposals become law.

The proposed retroactive effective date should not change clients’ fundamental investing. They will still invest in good investments regardless of the tax consequences, and investors will continue to buy stocks as long as the stocks they own continue to perform well and meet their expectations. Tax policy should never direct investment decisions.
 

 Tax policy should never direct investment decisions.


Tax planning strategies for investors to consider

 If a rate increase is enacted, there are a few tax planning strategies that will become more powerful. The first is an accelerating gain realization to a period before the effective date of any legislation. This is moot if the legislation is made retroactive but if the effective date is, for instance, January 1, 2022, gain realization in 2021 will be considerably less expensive than in 2022.
 
The second planning strategy to consider is charitable giving with appreciated securities. A taxpayer not only receives an income tax charitable deduction for the value of the security, but the capital gain is not realized when the security is transferred to a charity. This charitable strategy will also become more valuable in a high tax rate situation.
 
Lastly, investors may simply hold on to their investments for longer periods so as not to realize capital gains.
 

How capital gains can impact retirement planning

It’s imperative to think about how these tax laws are impacting not just tax planning and investing, but other areas of financial planning such as retirement planning. There’s currently a discussion about limiting a step-up in cost basis of an inherited asset (stocks, bonds, real estate, etc.) after someone’s death, which often reduces the capital gains tax owed by the recipient. If that does happen, advisors may be more aggressive with gain realization especially when working with more elderly clients on their estate plans. This will also be an important consideration for those planning their retirement.
 
If this change does come into effect, it may become more appropriate to increase fixed income investments in taxable accounts.
 

What you can do now to protect your assets and prepare for retirement

If approaching retirement, there are a few things that should be considered in advance within the 5 years leading up to retirement – especially when policy changes are happening that could impact your assets and retirement plan. Below is a brief checklist Cambridge Trust’s Wealth Management team recommends to clients if they are close to or within the 5-year mark:
 

This article is for informational purposes only and should not be construed as investment or legal advice. Please consult your tax advisor and/or legal counsel to determine if the strategies described above are right