Take steps to control your investment taxes
Published 3:27 pm Friday, April 27, 2018
Tax Season is finally over. Of course, how much you pay in taxes depends on a variety of factors, many of which you can’t control. But you might give some thought to how you can manage your investment-related taxes.
Here are some suggestions to consider:
• Contribute to your employer’s retirement plan. If your employer offers a 401(k) or similar plan, such as a 403(b) or 457(b), contribute as much as you can afford. The more pre-tax dollars you put in to your retirement plan, the lower your taxable income. Your employer also may offer a Roth 401(k) option, under which you invest after-tax dollars, so your annual income won’t be lowered and your withdrawals will be tax-free.
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• Contribute to an IRA. Even if you have a 401(k) or similar plan, you may still be eligible to contribute to an IRA. With a traditional IRA, your contributions may be fully or partially deductible, depending on your income level; with a Roth IRA, contributions are not deductible, but your earnings can grow tax-free, provided you’ve had your account at least five years and you don’t start taking withdrawals until you’re 59½.
• Follow a “buy-and-hold” strategy. You can’t control the price movements of your investments, but if you do achieve gains, you can decide when to take them – and this timing can make a substantial difference in your tax situation. If you sell investments that you’ve owned for one year or less and their value has increased, you may need to pay capital gains taxes at your personal income tax rate, which, in 2018, could be as high as 37 percent. But if you hold investments for more than one year before selling them, you’d be assessed the long-term capital gains rate, which is 0, 15 or 20 percent, or a combination of those rates.
• Consider municipal bonds. If you’re in one of the higher tax brackets, you may benefit from investing in municipal bonds. The interest on these bonds is typically free of federal taxes, and possibly even state and local taxes. Interest from some types of municipal bonds may be subject to the alternative minimum tax (AMT). However, because of the new tax laws, the AMT exemption amounts were increased significantly.
You might be wondering what these new laws mean to investors. In terms of your regular investment activities, the effect might not be that significant. The tax brackets for qualified dividends and capital gains – such as those realized when you sell stocks – will remain about the same. This means that most investors will continue to pay 15% to 20% on long-term capital gains and dividends. Consequently, the new tax laws shouldn’t really affect you much in terms of your decisions on buying and selling stocks or investing in companies that may pay dividends. Of course, it’s still a good idea to consult with your tax advisor on how the totality of the new laws will affect you.
Ultimately, your investment decisions shouldn’t be driven only by tax implications – nonetheless, it doesn’t hurt to take steps to become a tax-smart investor.