Ask Liz Weston

Get smart with your money

Taxes

Q&A: Clearing up some confusion over those proprietary funds

By

Dear Liz: Your recent column about proprietary funds confused me. You mentioned that selling these funds can trigger capital gains tax. Is it not true we can move investments directly from one money manager to another and not take a capital gain as long as the funds remain invested?

Answer: If you can move a fund from one investment company to another, then it likely is not a proprietary fund. For example, Schwab, Fidelity, Vanguard and many other firms create funds that bear their names, but these investments can be bought and sold at other brokerages.

Proprietary funds, by contrast, typically lock customers into investments that can’t be transferred to another firm. To get your money out, you have to sell the fund, which can trigger a tax bill. This is a significant downside and one investors should understand before committing their money to this type of fund.

Q&A: After a windfall, questions on what to do with the cash

By

Dear Liz: After selling my house and downsizing at age 84, I am cash rich for the first time in my life. My goal now is not so much to grow the money substantially, but to avoid paying taxes on my investments, as I would have to do with certificates of deposit. Are tax-free municipal bonds my best option, or what would you suggest?

Answer: If you’re in a high tax bracket — roughly 32% or higher — the lower interest rates paid on municipal bonds can still give you a good-enough return to make buying them worthwhile. If you’re in a low tax bracket, the math doesn’t work so well.

Also, municipal bonds aren’t covered by FDIC insurance the way a certificate of deposit would be. Investing in bonds involves some risk. The chances of default are minimal if you choose highly-rated bonds, but your bonds could lose value if interest rates rise.

Consider using some of your cash to consult a fiduciary, fee-only planner who can help you figure out a strategy that reflects all aspects of your financial situation, not just your tax bill.

Q&A: Tax Deductibility of Home Equity Loans and Lines of Credit

By

Dear Liz: You recently wrote about home equity lines of credit and home equity loans. You might have mentioned that these are tax deductible under certain circumstances.

Answer: Yes, but the circumstances are increasingly rare.

Technically, the interest on a home equity loan or line of credit can be deductible when the money is used to improve your home. However, you must be able to itemize your deductions to take advantage of this write-off. Thanks to increases in the standard deduction, fewer than 10% of taxpayers itemize.

Q&A: Proprietary investment funds might offer a personal touch, but they come with an important catch

By

Dear Liz: One subject I’ve never seen you address is the use of proprietary funds by financial advisors. We’ve taken over the finances of my in-laws, whose advisor put their money in a well-balanced portfolio, but all within a proprietary fund group. We are more or less stuck with continuing with their advisor because only certain agents can manage those funds. Also, getting out of the funds would require paying substantial capital gains. I am counseling my adult children as they make their investment choices to do as we have done and stick with funds that could be ported to other advisors or managed personally so they don’t get in a similar situation. Thoughts?

Answer: Proprietary mutual funds have enough potential disadvantages that people should do plenty of research before committing their money.

Brokerages and other financial institutions create their own proprietary or “house brand” funds to compete with the “name brand” or third-party funds managed by outside companies. But while a name-brand fund can be moved to another brokerage, a proprietary fund is typically just that — proprietary to the firm that created it, and not transferable. To get your money out, you would have to sell the proprietary fund and suffer any tax consequences.

Brokerages typically say that proprietary funds allow them to customize investments for their clients. That may be true, but proprietary funds also allow them to make more money, creating a conflict of interest.

Q&A: Giving your money away? The IRS wants to know about it.

By

Dear Liz: You recently wrote that “the only givers who have to pay taxes are those who have given away millions in their lifetimes.” I tend to be generous with my offspring who are the beneficiaries of my trust. For example, I gave a down payment on a house to my son last year. Because of long-held rental property investments, my estate is probably close to the $13-million lifetime limit. Since lifetimes don’t expire until we die, and I plan to live to 120, does this mean that until I give away over $13 million in cash, I don’t have to report or pay taxes in any given year on gifts?

Answer: Not quite.

You have to file a gift tax return to report any gift over the annual limit, which in 2024 is $18,000 per recipient. Gifts don’t have to be in cash to be reportable. If you’d given your son a house instead of a down payment, you’d still need to file a gift tax return.

Reportable gifts are deducted from your lifetime gift and estate exemption, which is $13,610,000. Once you deplete that exemption, you would have to pay gift taxes on any gifts above the annual limits. Even if you don’t deplete the exemption, reportable gifts will reduce the amount of your estate that can avoid estate taxes. You’d be wise to get advice from an estate planning attorney about how to handle gifts.

Q&A: When giving cash gifts, does anyone need to pay taxes?

By

Dear Liz: I am a widow age 95. I would like to give my three kids, who are in their 60s, $5,000 each this year. What are the taxes, and who pays them?

Answer: Gifts aren’t taxable to the recipients, and the only givers who have to pay taxes are those who have given away millions of dollars during their lifetimes.

Let’s start with the basics. You only have to file a gift tax return, which notifies the IRS of your generosity, when you give someone more than the annual exemption limit, which is $18,000 in 2024. So you could give your kids $54,000 before the end of the year and not have to tell the IRS.

You wouldn’t actually owe taxes on your gifts until the amounts you give away above that annual limit exceed your lifetime gift and estate limit, which is currently $13.61 million.

A taxable gift is typically deducted from the amount that avoids estate taxes at your death. But if you have enough money to worry about that, you should have an estate planning attorney who can advise you about how to proceed.