It might be too clichéd to mention the old adage about death and taxes, but much to our collective chagrin, that old cliché still rings true. No matter who is in office, which party controls Congress, or what direction the political winds might be blowing at any given time, taxes are an inevitability of life. However, that does not mean that you cannot significantly help your cause and minimize what you give to Uncle Sam – particularly with respect to your investments.
Invest According to Your Goals
When it comes to tax planning for your investments, taking a well-informed approach will always pay proverbial dividends down the tax road. For instance, if you’re explicitly investing for your retirement, always take advantage of tax-efficient accounts – including a 401(k), Traditional IRA, Roth IRA, or deferred comp plan – that can provide substantial tax benefits either now or in the future.
If your investment goal isn’t retirement but still something important like a down payment for a home five years from now, an IRA probably shouldn’t be your first choice in account type, but that doesn’t mean you still can’t employ a tax-efficient strategy. By using municipal bonds, for example, you can likely find a more robust interest rate than a money market or savings account that also offers you tax-free growth.
Be Mindful of Capital Gains
Although capital gain taxes don’t apply to investments held within tax-deferred retirement accounts, they should be very much a concern for any non-qualified accounts that don’t enjoy tax-efficient statuses like a 401(k) or IRA. Historically speaking, short-term capital gain tax rates tend to be a bit higher than those for long-term capital gains.
Therefore, it pays to always keep in mind the duration of time you have held every position in your portfolio to make sure any sales are subjected to as low a tax rate as possible. Thankfully, no matter who you invest through, unrealized capital gains are usually tracked on each statement for you.
Other Options
Aside from the more popular tax-efficient solutions like retirement accounts and municipal bonds, other tax-privileged account types exist but should be used with the prudent guidance of a trusted financial professional, given their often complex tax rules and restrictions.
Annuities are the most common of these alternatives. Offered in a handful of different types – mainly fixed, variable, and index – annuities can provide tax-deferred growth even when used outside of your retirement accounts. However, with vesting schedules, high fees, surrender charges, multitudes of riders, and other intricacies, always ensure that the tax efficiency you derive from an annuity is worth the many constraints.
When saving for college for someone in your immediate family, 529 accounts can offer significant tax efficiencies while leveraging the power of the investment markets to drive account growth. Each state has its own 529 plan, sometimes more than one, so once again, be sure to consult with a financial professional to make certain utilizing the tremendous benefits of a 529 account to ultimately serve your goals.
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