Benjamin Franklin famously said, ‘A Penny Saved is a Penny Earned’ and I couldn’t agree more. Investors are always looking for ways to grow their account balances and reducing their tax bill might be the simplest way. Here are a few ways to get more out of your investments by paying less in taxes:
- Long-Term Capital Gains – Hold investments a year or longer and gains are given favorable tax treatment over short-term gains (less than 1 year) which are taxed as ordinary income.
- Qualified Dividends – Many investors like to hold dividend paying stocks or mutual funds, but pay close attention to what type of income your investment generates. Qualified dividends are taxed at a lower rate than ordinary dividends. For example, many REITs and partnerships pay ordinary dividends which are taxed at your marginal (highest) tax bracket.
- Asset Location – Consider buying high dividend/high yield investments in a retirement account where the tax is deferred each year. On the other hand, be very careful what you buy in non-retirement accounts because the interest, dividends and capital gains can make their way onto your tax return.
- Municipal Bonds – Consider investing in bonds that pay tax-free interest.
- Index Funds and/or Exchange Traded Funds (ETFs) – Many index funds and ETFs have low turnover. As a result they typically don’t pass on as many capital gains distributions to shareholders as actively managed mutual funds.
- Look Ahead at Your Income for Tax Bracket Changes – Low income years may be good for intentionally taking on more income (would you pay 15% now to avoid a 25% tax later?) and high income years should be planned around by taking losses, deductions or deferring income to other years.
- Use Roth IRAs – You don’t get a tax deduction on the small amounts going into these accounts, but typically, whatever large amounts they may grow to can be withdrawn tax-free.
Learn to pay attention to what you will pay in taxes so you can keep more of what you earn!