Investing Success: Keeping an Eye on Taxes
May 14, 2024
Avoiding taxation should not be the only goal, or even the main goal, of your investment strategy. Still, you always have to keep taxes in mind to make sure you're not unnecessarily sending too much of your money to the government.
Keep on top of your tax losses. No one likes to see their investments fail, but there are hidden tax savings there. Tax-harvesting strategies take advantage of losses for tax benefits when you rebalance your portfolio if you comply with IRS rules on the tax treatment of gains and losses. Note that losses can offset up to $3,000 in taxable income in realized investment gains annually. If losses exceed deduction limits in the year they occur, you may be able to carry them forward to offset gains in future years.
Also watch out for capital gains. Securities held for more than 12 months and sold at a profit are taxed as long-term gains, with a top federal rate of 23.8%. For short-term gains, the tax rate can hit 40.8%. Timing can be everything.
Consider tax-exempt securities. Municipal bonds typically are exempt from federal taxes and may receive preferential state tax treatment. However, choose carefully before jumping into them. If you have a low tax rate in retirement, for example, it may not be necessary or even wise to concentrate so heavily on avoiding taxes.
Managing Your Taxes
Sometimes it's better to pay taxes later rather than now. For example, 401(k)s, 403(b)s, IRAs and tax-deferred annuities let you postpone your taxes until you are retired and thus likely in a lower bracket. Contributions you make may reduce your taxable income if you meet income eligibility requirements, and typically, investment growth is tax-deferred.
On the other side of the coin are Roth IRAs, which don't give you an immediate tax break, since you use after-tax dollars. But this can help you later. For example, you may be in a low tax bracket now, so you put money into a Roth IRA. Investment gains are tax-deferred. When you withdraw the money, you don't have to pay taxes at what could be a higher rate.
Reduce Taxes Through Charity
If you itemize, you can deduct the value of your charitable gift from taxable income, but be aware that limits apply. Consider contributing appreciated stock, which may help you avoid capital gains taxes. Also try a donor-advised fund in a high-income year. These funds let you make a donation, take an immediate deduction and spread the giving over a period of time.
Of course, this is just an introduction to a complex topic — there are limits and exceptions to these strategies. Tax law is detailed, especially when it comes to investments, and a slight miscalculation on your end can lead to an unexpected tax bill down the line. The point is to recognize that taxes are a key part, but not the only part, of an investment strategy, and you need to work with tax and financial professionals to make sure your strategies are aligned with your goals.
Source: Industry Newsletters ©2024
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