This is a good news/bad news story for many investors. At Riverwater, we look for mutual fund managers who actively manage the portfolio of stocks under their management, meaning that they make buy and sell decisions regularly in the underlying stocks in their funds.

To the benefit of those of us who own the funds, many saw robust performance during 2021 and much of that can be attributed to that active management. When managers sell stock positions that have performed well, or trim back on those holdings in the funds, they create capital gains attributable to those sales. And here is the bad news. Those capital gains are passed on to the investors in the fund(s). The capital gains are usually reported to shareholders in the final month of the year and appear on your year-end tax statement.  The good news is that the fund managers have successfully made most of us a nice rate of return over the last several years; we now owe tax on the gains.

Long term capital gains are not taxed as income, but at a rate between 0 – 20% depending on your taxable income.  Couples earning less than $83,350 in 2022 pay no tax on capital gains; couples making between $83,351 and $517,200 pay 15% on the gain; over $517,200 the rate is 20%. Distributions from a traditional IRA are included in gross income and are subject to ordinary state and federal income taxes.

Capital gain taxes never apply to tax deferred or tax free accounts such as IRAs and Roth IRAs. 

The max contribution increased by $1000 in 2022, to $20,500 plus an additional $6500 if you are 50 or older.  If you contribute to a Solo 401(k) plan as a business owner, the limits are increased and are more complicated because they include both employee and employer contributions.

One of the greatest savings accounts that allows for tax-free growth and withdrawals is a Roth IRA.  But, there are rules (of course!).  First and foremost, you need to have “earned income” to even consider making a contribution.  The answer to this question should be posed to your accountant, but if you are only receiving a pension, IRA or income considered “passive,” you will not be eligible for a Roth IRA contribution.

Even if you meet the earned income criteria, not everyone is eligible to make a Roth contribution.  Eligibility is phased out based on your MAGI (modified adjusted gross income):

• Married, filing jointly: Phase-out starts at $204,000 MAGI.
• Single or Head of Household: Phase-out starts at $129,000 MAGI

The IRS says that when death occurs on or after the account holder’s “required beginning date” (usually at age 72), the non-spouse beneficiary has 10 years to take a full distribution of the inherited IRA (or qualified plan). The IRS changed the rules surrounding non-spouse beneficiaries with the SECURE Act passed in 2019, eliminating the so-called “stretch IRA.” This gives you some flexibility and allows you to take the withdrawals in a series of withdrawals or a lump sum at the beginning or end of the period.

The main point here is that the account should be distributed in full by the end of 10 years of the inheritance. If you have inherited a Roth IRA, the same rules apply (10 years for full withdrawal). None of the gains or distributions are taxable.