Tax-Efficient Investing Not As Difficult As It Seems


It is important for every investor to be aware of how taxes will affect their investments and returns. Investors in the United States generally receive their 1099 Forms detailing their income from brokerage accounts towards the beginning of February. Taxes due from the income on these investments must be paid on or before April 15 to avoid expensive tax penalties. Investment portfolios can be structured for optimal tax efficiency if the investor carefully considers their plan for each investment instrument.

Create A Plan

It takes year-round vigilance to ensure that your tax burden from investing is minimized for the tax year. The best course of action is to create an investment strategy before you start investing in new investments. The basic rule of thumb for tax-efficient investments is use a taxable account if you plan on withdrawing money within a few years and use a tax-deferred investment vehicle if you plan on holding on to the investment long term.

Use Different Investment Vehicles

Investing in retirement accounts, such as a 401(k) or individual retirement accounts, is tax-deferred until the account owner withdraws the money for their personal use. A Roth IRA is funded with after-tax contributions, so there are no taxes on withdrawals as long as the withdrawals are made after the minimum retirement age. However, in nonqualified brokerage accounts any earnings, such as dividends, are taxable for the year in which they are received. Any gains on investments held less than one year are taxed at a higher rate than ones held long term.

Think Before You Sell

Before selling stocks from your portfolio, consider how it will affect your tax bill for that year. In some instances, you will find that it is better to delay selling the stock until the next calendar year to limit your capital gains taxes for any particular year. However, if the stock is a volatile one or in an industry that is experiencing a downturn, a delay may cost you more than you would save in taxes.

You can also save on taxes if your investing has caused you to lose during the tax year. By using a strategy known as tax-loss harvesting, you can sell the devalued stock at a loss to create a capital loss that will offset your capital gains. However, if you sell at a loss, you cannot purchase the same stock back within a set amount of time, typically 30 days, without incurring a penalty due to the “wash-sale” rule.

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