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For many investors, it isn't what you earn that counts — in the end it’s what you keep that matters. While taxes are inevitable, there are a number of long-term, tax-smart investing strategies that may help you keep more of what you earn.
Some investments are taxable, some tax-free, some tax-deferred and some tax-efficient. It’s important to make sure you are choosing the right type of investment for various accounts. Investments that generate taxable income, such as taxable bond funds or stock funds, may be better held in tax-deferred accounts — such as your IRA. Save the municipal bond funds or tax-sensitive investments for your regular, taxable accounts.
Then, make sure you're taking full advantage of tax-efficient investments. For instance, municipal bond funds generate income that is free from taxation at the federal level and, in some cases, the state and local levels as well. Other tax-smart investments include tax-sensitive mutual funds, and index funds or Exchange Traded Funds (ETFs), which typically utilize a buy-and-hold strategy.
Tax deferral simply means that you postpone the payment of taxes until a later date — usually when you withdraw your money. This keeps your money working, and earning more, rather than going to pay taxes each year. It may not seem like much, but it can make a big difference in helping you achieve your financial goals.
There are a number of tax-deferred savings vehicles available to you as an investor, such as IRAs, 401(k)s, 403(b)s and 529 plans. Remember, you generally will be subject to taxes at the time you withdraw assets from a tax-deferred account.
Retirement may seem far away, but starting early is crucial. Even if you can only save a small amount each year, you'll be better prepared to live comfortably in retirement. If you wait, you'll have to save much more each year in order to save the same amount and have enough money to retire at the age you'd like. Here’s a brief look at some of your retirement saving options.
An early distribution from a traditional IRA prior to age 59½ may be subject to a 10% excise tax penalty.10% federal income tax withholding (and any applicable state withholding) may also apply. Please consult your tax advisor to determine if an IRA is a suitable investment for you.
Make sure you are aware of a fund’s annual distribution date. If you buy shares right before capital gains are distributed, you will receive a distribution and have to pay tax on gains earned throughout the entire year, even though you are a new investor.
Further, when it comes time to sell, you may, or may not, wish to wait for distributions to be made. This will depend on the size of the gain, whether or not you are selling at a loss, and your tax strategy.
If you have investment losses, you may be able to offset them with your investment gains each year. Tax-loss harvesting can help reduce your income tax liability, particularly for investors in the highest income tax brackets. In fact, if your losses exceed your gains, you might also be able to offset up to $3,000 in earned income.
The Alternative Minimum Tax (AMT) was created in the late 1960s to prevent very wealthy people from living tax-free. However, because it was never indexed for inflation, many middle-income taxpayers are finding that they also owe the AMT — particularly if one or more of the following apply:
If you are already affected by the AMT, or are close to it, speak with a tax advisor or other professional to find out what steps you can take for better AMT planning.
For taxpayers who itemize their deductions, there may be a way, if appropriate to write off your charitable gifts. Instead of giving cash to your favorite charity, consider donating stocks that have substantially appreciated in value. This way, the cost of your donation is the lower, original purchase price, but you can deduct the higher, current market value of the stock — and you won't be hit with any capital gains taxes.
This information is general in nature and is not intended to constitute tax advice. Please consult your tax advisor for more detailed information on tax issues and for advice on your specific situation.