Spring 2007

When Discussing Financial Diversity with Your Advisor, Remember Tax Diversity

By Kathryn Capage, First Vice President and Strategic Planning Director for AIM's Tax Advantaged Products Division, AIM Investments®

Over the past decade taxpayers have learned (hopefully, not the hard way) that financial diversity may be the best way to spread the risk of the unknown. Whether through the lessons learned from the dot-com bubble burst or the 401(k) retirement collapse for Enron employees, many taxpayers are now focused on a balanced approached to life-income planning.

For better or worse, I've studied and lived with the tax code for more than 33 years. I've never seen this system more riddled with temporary "patches" and expiration dates than I do today. With a tax system so erratic and susceptible to change at any given congressional moment, how do we, as taxpayers, structure our investments so what gains we make are not erased with future taxes? One thought to consider is-tax diversity.

There are many paths to tax investments, but the three primary tax structures are: taxable investments, tax-deferred investments and tax-free investments. All three have good and bad points. All three have tax futures with questions. For example, many taxable investments are subject to capital gains or dividend taxes, which are currently at a low tax rate thanks to the 2003 tax cut. Currently, dividends and capital gains have a maximum tax rate of 15% with an even lower rate of 5% for taxpayers in the 10% to 15% tax brackets; however, this rate is due to expire by the end of 2010. Then what?

Or take your retirement plan investments like 401(k)s or IRAs. Investments in these plans are tax-deferred-not subject to capital gains or dividend taxes-and are allowed to grow in value until a specific time when the investments are distributed and taxed as ordinary income. You know what your income tax rate is today, but what will it be years or even decades from now when you need these investments for your retirement?

As for the more recent tax-free savings, Congress designed the Roth IRA, Roth 401(k) and Roth 403(b) to allow eligible taxpayers to forego tax deductions today in order to reap the benefits of a tax-free distribution in the future. But what will the tax code look like in this future?

Without a crystal ball, I believe the best course is the one that has worked soundly for financial planners-diversity. Ask your financial advisor to categorize your investments by their tax structure. Then discuss whether you should invest more in your 401(k) deferral or add more to your taxable investments. Also, review the tax-free Roth structure to see if you should contribute, if eligible, or convert existing investments to Roth.

Then, when Congress alters the tax code yet again, you can sit back and say, "Hey, at least I'm diversified."

Consider the investment objectives, risks, and charges and expenses carefully. For this and other information about AIM funds, obtain a prospectus from your financial advisor and read it carefully before investing.


The opinions of the article are solely the opinions of Kathryn Capage and do not reflect the opinions of A I M Distributors, Inc. or any of its affiliates.

AIM Investments is a registered service mark of A I M Management Group Inc. A I M Advisors, Inc., A I M Capital Management, Inc., and AIM Private Asset Management, Inc. are the investment advisors for the products and services represented by AIM Investments.
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