Robert McRae, AAMS®
Edward Jones Financial Advisor
The tax return deadline has been extended until mid-July, but you may have already filed your taxes. If you were not entirely happy with the results, you might start seeking ways to change the outcome for next year. And one area to look at may be your investment-related taxes.
To help control these taxes, consider these moves:Take full advantage of tax-deferred investments. As an investor, one of the best moves you can make is to contribute as much as you can afford to your tax-deferred accounts – your traditional IRA and 401(k) or similar employer-sponsored plan – every year. If you don’t touch these accounts until you retire, you can defer taxes on them for decades, and when you do start taking money out, presumably during retirement, you may be in a lower tax bracket.
Look for tax-free opportunities. Interest from municipal bonds typically is exempt from federal income tax, and, in some cases, from state and local income tax, too. (Some municipal bonds, however, may be subject to the alternative minimum tax.) And if you qualify to contribute to a Roth IRA – eligibility is generally based on income – your earnings can be withdrawn tax-free, provided you’ve had your account for at least five years and you don’t start taking withdrawals until you’re at least 59-1/2. Your employer may also offer a Roth 401(k), which can provide tax-free withdrawals. Keep in mind, though, that you contribute after-tax dollars to a Roth IRA and 401(k),unlike a traditional IRA and 401(k), in which your contributions are made with pre-tax dollars.
Be a “buy and hold” investor. Your 401(k) and IRA are designed to be long-term investments, and you will face disincentives in the form of taxes and penalties if you tap into them before you reach retirement age. So, just by investing in these retirement accounts, you are essentially pursuing a “buy and hold” strategy. But you can follow this same strategy for investments held outside your IRA and 401(k). You can own some investments – stocks in particular – for decades without paying taxes on them. And when you do sell them, you’ll only be taxed at the long-term capital gains rate, which may well be less than your ordinary income tax rate. But if you’re frequently buying and selling investments you’ve held for less than a year, you could rack up some pretty big tax bills, because you’ll likely be taxed at your ordinary income tax rate.
Be prepared for unexpected taxes. Mutual fund managers are generally free to make whatever trades they choose. And when they do sell some investments, they can incur capital gains, which will be passed along to you. If this is a concern, you might look for funds that do less trading and bill themselves as tax efficient.
While taxes are certainly one factor to consider when you invest, they should probably not be the driving force. You need to build a diversified portfolio that’s appropriate for your risk tolerance and time horizon. Not all the investments you select, and the moves you make with them, will necessarily be the most tax efficient, but by working with your financial and tax professionals, you can make choices that can help you move toward your long-term goals.
This article was written by Edward Jones for use by your local Edward Jones Financial Advisor.
Edward Jones, Member SIPC
Edward Jones, its employees and financial advisors cannot provide tax or legal advice. You should consult your attorney or qualified tax advisor regarding your situation.