A century ago, author Mark Twain wrote that the difference between a taxidermist and a tax collector is that the taxidermist only takes your skin. Today, the IRS isn’t any more popular. Why not see if any of the following strategies could allow you to keep more of what your investments earn?
1. Look into tax-managed mutual funds. Portfolio managers of tax-managed funds can use a number of strategies to help reduce the tax bite shareholders suffer. For example, they may strive to keep portfolio turnover low to help minimize taxable gains, or they may actively use losses to offset taxable gains.
2. Consider municipal bonds and bond funds. Because the interest on a municipal bond is usually exempt from federal taxes, and sometimes state and local taxes, it may actually produce a better yield than a taxable bond with a comparable interest rate. The higher your income tax bracket, the more you may benefit from owning “munis.”1
3. Contribute to tax-advantaged retirement vehicles. You can now contribute up to $5,500 annually to an IRA plus an additional $1,000 per year if you’re over age 50 (for the 2014 tax year). Traditional IRAs offer tax deferral – you pay no taxes on earnings until withdrawal – and may provide tax deductions. Roth IRAs offer tax deferral and qualified withdrawals are tax free, but no tax deductions.2
4. Use gains – and losses – to your advantage. If you have an investment and hold it for at least one year before selling, you’ll pay a maximum federal tax of 20% on capital gains. The same rate applies for dividend income. 3 Keep it for less than one year and you’ll pay regular income taxes – up to 39.6%. Also keep in mind that if you intend to sell investments that have lost money, you can do so by December 31 and deduct up to $3,000 in investment losses from that year’s tax return. Additional losses can be carried over and used to offset future capital gains.
There are other tax strategies you can use, but be sure to consult your tax professional and investment professional before acting.
1 Income may be subject to the alternative minimum tax. Capital gains, if any, are subject to taxes.
2 Withdrawals before age 59½ are subject to a penalty tax. Each type of IRA has respective income limits as well as deductibility rules.
3 Lower rates apply for long-term capital gains and dividends for taxpayers who are in lower tax brackets. An additional 3.8% Medicare tax may also apply.
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