End-of-the-Year Help

12/15/2006 12:00 am EST

Focus:

Janet Brown

Editor, NoLoad Fund*X

Fund guru Janet Brown's subscribers often get a little extra in their stocking. Her expertise in mutual funds is accompanied in her most recent issue with these timely year-end tips to help soften investors' tax burdens.

"Charitable contributions help others while also potentially reducing your income tax liability. Donor-advised or Charitable Gift Accounts (available at Schwab, Fidelity, Vanguard and many community foundations) can make planned giving easier and simplify your record keeping.

"In these accounts, an individual typically contributes at least $5,000 in cash, funds or other assets; gets an immediate tax deduction for the contribution; and, over time, recommends how the money should be distributed to charitable organizations. You can make one contribution and let the donor-advised account handle sending the checks to 10 separate charities. Or, you can postpone choosing which charities to support, and in the meantime select investments from a menu that may include mutual funds, or more customized separately managed accounts.

"Because they are irrevocable charitable gifts, donations are usually fully deductible in the tax year in which they are made. This allows you to fund a future of charitable giving while receiving income-tax deductions right away. If you fund your account with appreciated fund shares, you enjoy a further benefit of donating assets before realizing the gain and tax liability. So, it's beneficial to gift fund shares where you have the biggest gains.

"There's a temporary tax break this year and next for IRA holders age 70-1/2 and above (both traditional and Roth IRAs). The Pension Protection Act of 2006 allows tax-free distributions of up to $100,000 for tax years 2006 and 2007, provided the assets are donated to qualified charities. Tax regulations are complex. It is your responsibility to ensure that the charitable organization meets the qualifications of the legislation. If you have questions, please consult a tax advisor.

"One of the frequently cited benefits of Exchange Traded Funds (ETFs) is their relative tax efficiency versus traditional mutual funds. Like all mutual funds, ETFs must distribute realized capital gains and income at least annually. However, most ETFs have been able to limit their realized gains because shareholder activity never affects an ETF.

"When individual investors buy and sell shares, they trade among each other. Large orders are purchased and sold in kind through authorized dealers, and low cost basis stock is thereby purged from the ETF without a realized taxable event. Because most ETFs are index-based, portfolio turnover tends to be minimal, driven by index changes and rebalancing, versus active portfolio management.

"Still, not all ETFs are alike. Some newer ETFs incorporate more active management, and may therefore pay distributions."

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