Saving money on taxes has the effect of compounding, giving you more to invest.
Benjamin Franklin famously said, “A Penny Saved is a Penny Earned” and we couldn’t agree more. Investors are always looking for ways to grow their account balances. 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 make their way onto your tax return.
- Municipal Bonds – We have seen even well known money managers invest in bonds that pay taxable interest without any regard for taxes when there may be similar tax-free alternatives.
- Index Funds and/or Exchange Traded Funds (ETFs) – Many index funds and ETFs have low turnover and as a result don’t typically pass on as many capital gains distributions to shareholders.
- 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tax deduction on the small amounts going into these accounts, but typically, whatever large amounts they grow to can be withdrawn tax-free.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!
