Tax-Efficient Investing Investment strategies should not be based solely on taxes, but investors should consider any opportunities to defer, manage and reduce taxes.
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Defer Taxes. The largest tax benefits available to most investors is the ability to defer taxes through retirement accounts, such as 401(k)s, 403(b)s, IRAs, and tax-deferred annuities. When using a traditional retirement account, you receive the benefit of reducing your current taxable income while also deferring taxes on any investment growth within the account(s). Investors should consider locating and holding investments that generate certain types of taxable distributions within a tax-deferred account rather than a taxable account. In doing so, you will be maximizing the tax treatment of those accounts.
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Manage Taxes. Decisions you make about when to buy and sell investments you own can determine your tax burden. While you should never let the tax tail wag the investment dog, these concepts should be incorporated into your portfolio management style. As an example, a loss on the sale of a security can be used to offset any realized investment gains. In addition, $3,000 in taxable annual income can be used against the loss. If your losses exceed the limits for deductions in the year they occur, the tax losses can be carried forward to offset investment gains in future years. Securities held more than 12 months are taxed as long-term capital gains or losses with a top federal rate of 20% in 2021, which can be more advantageous than recognizing a short-term capital gain which would be taxed as ordinary income. Being aware of holding periods is an intelligent way to avoid paying higher tax rates.
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