Some investors devote endless hours to researching high-yielding stocks, bonds, and mutual funds. They study publications, watch financial seminars, and seek help and advice from friends. However, many of these investors may be forgetting another option to boost their profits: tax efficiency. Perhaps you’re one of them! Fortunately, it doesn’t have to be difficult. All it takes is a little forethought. Read on to learn how to get started with tax-advantaged investing right away.
Every investment comes with a price tag. Taxes are the most expensive of all the costs, and they can eat up a large portion of your earnings. The good news is that tax-efficient investing can help you reduce your tax bill while also increasing your bottom line, whether you’re trying to save for retirement or make money.
Which Account Do I Have To Choose?
If you want to invest in a tax-efficient way, it is first of all important to choose the right account for your investments. Generally there are two type of accounts: taxable accounts and tax-advantaged accounts.
A taxable account would be a brokerage account, for example. These accounts are not tax-advantaged, but they do have less limitations and greater freedom than tax-advantaged accounts like IRAs and 401(k)s. Unlike an IRA or a 401(k), you can take your money from a brokerage account at any time, for any reason, and without incurring any tax or penalty.
Generally, tax-advantaged accounts are either tax-deferred or tax-free. Traditional IRAs and 401(k) plans are examples of tax-deferred funds that provide an immediate tax benefit. You may be able to deduct your payments to these programs, giving you a tax break right now. Taxes are paid when you withdraw money in retirement, therefore the tax is delayed.
How to Reduce Taxes
The United States tax system encourages charitable giving by allowing you to deduct the value of your contribution from your taxable income if you itemize your taxes (limits apply). These tax-aware tactics will help you get the most out of your funding:
Capital gains should be long-term: Investing for long-term capital gains is a good option. Even if you pay the highest tax rate, long-term capital gains will only be taxed at a rate of 20%.
Maintain your portfolio in tax-advantaged accounts: Tax-sheltered investment accounts, such as 401(k)s, 403(b)s, and various IRA plans, allow you to grow your money without worrying about taxes.
Choose real estate investments: Real estate investing can provide both cash flow (in the form of positive rent revenue) and capital gain (in the form of rising property values). It also comes with three significant tax benefits: a good cash flow situation and the property’s value can rise, but it won’t be taxed until it’s sold, allowing it to qualify as a long-term capital gain (which means: lower income taxes)
Beyond your employer match, contribute to your 401(k): A 401(k) account is the first investment most people with a full-time job would discover as adults. If they work in education or for a non-profit organization, it’s a 403(b) account. If they work for the government, they’ll also have a 457 account. In any case, it’s a chance to save money on your taxes.
Real estate or privately held business interests can be donated: You can obtain an income-tax charitable deduction and avoid capital gains taxes by donating a non-publicly traded asset with unrealized long-term capital gains. If held for a long time, shares purchased through an employer stock program are often ideal candidates for donation and can help to lessen a dominant position.
Buy appreciated stock instead of cash: You can normally get a fair market value (FMV) deduction and possibly avoid capital gains taxes by donating long-term appreciated stocks or mutual funds to a public charity. If you combine these factors, you may be able to donate up to 23.8 percent more than you would if you had to pay capital gains taxes.
Conclusion
Tax minimization is one of the most important aspects of investing (whether you’re saving for retirement or making money). Holding tax-efficient investments in taxable accounts and less tax-efficient investments in tax-advantaged accounts is a solid method for minimizing taxes. That should provide your accounts the best chance of long-term growth.
Always seek the advice of a qualified investment planner, financial counselor, or tax specialist to determine the optimal tax approach for your circumstances and objectives.