Tell me about taxes on investment gains (Lifetime Planner)

Gains are determined using the tax basis of your investments. The tax basis is the original cost you paid for the investment (plus expenses) that must be reported to the IRS when you sell the investment. The basis is used for calculating capital gains or losses. For example, if you bought a stock for $1,000 two years ago and sold it today for $1,500, your income tax return would show a basis of $1,000 and a taxable capital gains profit of $500.

If you entered your investments without the original purchase price, you probably have an incorrect cost basis. To get an accurate cost basis, edit the initial transactions for your investments to make them correct. If you don't know the exact basis, make your best guess.

The gains on your taxable investments are taxed at the rate you specify in the Average Tax Rate dialog. For example, if you have a $1,000 investment in your taxable portfolio and you have set your taxable portfolio to get an average rate of return of 10 percent, then your gain for the year is $1,000 x 10 percent = $100. However, if your tax rate is 25 percent, only $75 of that gain is reinvested ($100 x 25 percent = $25 tax, $100 - $25 = $75 reinvested). What this means is that the Lifetime Planner assumes you will pay the taxes on your portfolio gains out of the portfolio itself.

To further complicate things, unrealized capital gains can alter this equation slightly. To continue the example from above, your total gain of $100 can be divided into two pots. The first contains gains from interest, dividends and realized capital gains. These gains are 100 percent taxable each year.

The second pot contains unrealized capital gains that are not taxable until you actually sell the investments. Depending on which types of investments are in your portfolio, a certain percentage of your gains will be taxable and a certain percentage will not. By default, the Lifetime Planner assumes all gains are taxable. With this default, the example above doesn't change.

However, if you have indicated that only 60 percent of your gains are taxable each year, the above example changes as follows: You have a $1,000 investment in your taxable portfolio and you have set your taxable portfolio to get an average rate of return of 10 percent. Again, your gain for the year is $1,000 x 10 percent = $100. Of that $100, only 60 percent of it is subject to taxes; $60 is taxed at 25 percent for a tax of $15. Only the after-tax amount is realized, so $85 is reinvested for next year. Of course, when the unrealized gain is finally realized (by selling the investment via a withdrawal), the unrealized gain will be taxed.

Taxes are assessed in the year you sell the investment.

Not Available in Canada

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