Rearrange retirement portfolios to save on taxes

Take capital gains, liquidate dividend-paying stocks; consider tax-deferred annuities

Oct 31, 2010 @ 12:01 am

By Nancy Mandell

Financial adviser Chris Hobart admits that congressional inaction on tax laws had him in “handcuffs,” but he's determined to cast off the shackles and take control.

With a client base of 70- to 80-year-old retirees worth from $5 million to $15 million each, Mr. Hobart is turning his attention to capital gains and dividends — staples of a retirement portfolio.

“We still don't know what changes to anticipate in the tax laws, so right now, our focus is on strategies for what we can anticipate,” he said.

“At 15%, capital gains are at a very low rate, so in anticipation of their rising at least to 20%, we're looking at liquidating long-term capital gains in their portfolios,'' said Mr. Hobart, the primary adviser at Hobart Financial Group Inc., which manages $150 million.

“Capital gains are seen as a rich man's tax,” he said. That perception leads Mr. Hobart to wonder whether the rate might even go higher than 20%. “This is the lowest you'll see them [taxed] in the foreseeable future,” he said. “So if you're not in love with them, get rid of them.”

Mr. Hobart has also begun “pulling back a bit” from dividend-producing stocks. Like many in the business, he thinks “there is going to be potential for folks to pull money out of dividend-producing stocks, and we want to be in the forefront.”

Mr. Hobart and his team have considered the alternatives. One option was municipal bonds, but they were rejected because he finds rates “far too low to work.”

Instead, Mr. Hobart has been looking at alternative investments that he believes to be “more tax-efficient,” such as privately issued real estate investment trusts. “What I like about them is that they are 70% taxable and 30% tax-free,” he said.

Another product under consideration is annuities. An annuity, he said, allows an investor to have some tax deferral and to choose when he or she wants to pay the taxes.

“The concept is that with dividend-paying stocks, if rates go from 15% to potentially as high as 39.6%, you'll see a forced tax event. Dividends control us whether we use them or not, and they're taxed at a higher rate.”

Mr. Hobart's advice?

“If you don't need the income [from dividends], a tax-deferred annuity is a stronger vehicle because you can just wait and reinvest the dividends,” he said. “The advantage is triple tax compounding: Your money grows, your growth grows and the taxes you would have paid grow as well.”

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