The New Tax Law

Capital gains that you generate in a tax-deferred account are taxed as ordinary income when you withdraw them. So under the new law, you are sheltering your profit from a 20 percent-or-lower capital gains tax, only to pay income tax on it later at a rate as high as 39.6 percent. With an annuity, this disadvantage is especially acute. Financial planners estimate that to overcome the unfavorable tax-rate spread

Hugh F. Doherty, DDS, CFP

Look askance at annuities

Capital gains that you generate in a tax-deferred account are taxed as ordinary income when you withdraw them. So under the new law, you are sheltering your profit from a 20 percent-or-lower capital gains tax, only to pay income tax on it later at a rate as high as 39.6 percent. With an annuity, this disadvantage is especially acute. Financial planners estimate that to overcome the unfavorable tax-rate spread

and an annuity`s sky-high insurance and investment fees, an investor facing a 28 percent-or-higher tax on withdrawals would have to rack up tax-deferred gains for 15 to 25 years to come out ahead. And now the fine print ...

The New Tax Law

Starting on your 1998 return, you can deduct 14 cents a mile for using your car to do charity work, up from 12 cents.

You can write off a home office where you do paperwork, starting in 1999, even if most of your work is done elsewhere.

Repealed: The 15 percent excise tax on annual payouts above $160,000 from tax-favored retirement plans.

A potent, new investment tool - the Roth IRA

Here is how it works: Starting in 1998, a husband and wife with AGI up to $150,000 (and singles up to $95,000) each can make annual contributions of $2,000 to the Roth IRA. Those contributions are nondeductible. They do, however, grow tax-deferred and - here is the beautiful part - the proceeds can be withdrawn tax-free after five years, provided you are using the money for a first-time home purchase. With the traditional IRA, by contrast, both your contributions and their earnings are taxed upon withdrawal.

For many taxpayers, the Roth IRA promises greater long-term benefits than the traditional IRA that is deductible up-front. As long as your income tax rate stays the same or goes up when you withdraw your money, you end up with more money in a Roth IRA than a traditional IRA.

Run the numbers to see if you should convert your current IRA to a Roth IRA.

If your AGI is less than $100,000, the new law lets you roll your existing IRAs, deductible or traditional, into a Roth IRA. If you do so, you will owe income tax on all previously untaxed contributions and earnings.

One perk: The new law lets you spread the resulting tax bill over four years, if you execute the rollover before January 1, 1999.

The Big Question

Is it worth paying that tax now, in return for tax-free withdrawal later? If you expect your income tax rate to drop when you retire, the answer is almost certainly "no." If you expect your tax rate to be higher in retirement - say, if you are a young professional likely to earn and save a lot - the answer is probably "yes."

Other considerations include the number of years you will invest in the IRA before beginning to cash out and whether you can afford to pay tax on the rollover without dipping into the IRA. The calculation can be complex, and, for many taxpayers, it is worth seeking help from a tax advisor.

Your Investments

The new tax law cuts the top tax rate on long-term capital gains by nearly a third, to 20 percent from 28 percent. In general, for your gain to qualify as "long term" under the new law, you must hold your assets for more than 18 months before selling vs. 12 months under the old law. But the new rates also apply to assets sold from May 7 through July 28 that you had owned for more than one year and to assets you sell after July 28, as long as you have owned them for more than 18 months.

Finally, for assets you buy on or after January 1, 2001, and hold for at least five years, the top capital gains rate will fall to 18 percent.

1) Sell some of your overpriced winners.

Stocks, especially blue chips, are overpriced. Investors are urged to sell as much as 20 percent of their holdings and rebalance portfolios that have become dangerously overloaded with stocks during the seven-year bull market. The new, lower capital gains rates make this even more compelling.

2) Shelter interest and dividends in your tax-advantaged accounts.

While the new law sharply cuts taxes on capital gains, it leaves interest from bonds and dividends from stocks to be taxed at the same rates as ordinary income: up to 39.6 percent. It now makes more sense than ever to use tax-advantaged retirement accounts, such as 401(k)s and IRAs, to hold your taxable bonds and high-yield stocks.

3) Go for growth in your taxable accounts.

The new law makes long-term investment in growth stocks the most attractive option for your taxable accounts. That is because the returns on such shares come almost exclusively in the form of capital gains, which are taxed - only after you sell - at the new low rate.

Mutual fund investors also can take advantage of the new tax law by choosing growth-stock funds that keep their taxable short-term capital gains to a minimum. Some fund managers, for example, are adept at offsetting gains with losses - a tactic that helps to hold down annual distributions of those gains to the fund`s investors. To find such funds, look for a tax-efficiency ratio of at least 85 percent; you can find the figure in Morningstar`s comprehensive fund rankings. Also, check out a fund`s turnover rate, which measures how long a manager tends to hold the stocks in a fund before selling. Look for a low turnover rate - say, under 50 percent - which indicates that a manager holds his or her stocks an average of two years, thus helping to ensure that distribution is long term. A good pick:

Vanguard Index Total Stock Market (three-year annual return to August 1: 28.3 percent; 2 percent turnover).

Florida 1998 Winter Workshops - Do your practice a favor - close it for a few days. Come and learn about retirement, personal and practice financial control.

Hugh F. Doherty, DDS, CFP, is a national lecturer, financial advisor to the health-care profession and CEO of Doctor`s Financial Network. For personal financial consultations or to have Dr. Doherty speak to your study club or dental society, call (800) 544-9653.

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