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2 minute read
Tax-Efficient Investing
Investment strategies should not be based solely on taxes, but investors should consider any opportunities to defer, manage and reduce taxes.
1. 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.
2. 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.
–Dolly Parton
3. Reduce Taxes. There are various charitable giving strategies you can employ to reduce your tax burden while also supporting charities and those in need. These strategies include, but are not limited to: a. By donating long-term appreciated securities to a charity, you can avoid paying capital gains tax on the appreciation while also claiming the fair market value of the security as an itemized deduction on your federal income tax return. b. If you are at least 72 and have an IRA, you can satisfy your required minimum distribution requirement while also lowering your taxable income by transferring up to $100,000 annually per taxpayer directly from your IRA to a charity by making a qualified charitable distribution (QCD). c. You could establish a donor-advised fund; in doing this, you can contribute to the fund and qualify for a charitable deduction without deciding right away on which charity(ies) to support.
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–Ralph Waldo Emerson