It’s the time of year when most folks take a financial check-up—assessing how well we did during the year managing our income and expenses—and most importantly—how we can keep more of our money and give less to Uncle Sam. For those who buy and sell stocks, it’s important to know how to reduce your investment taxes.
And for investors in 2017, when the Dow Jones Industrial Average has gained more than 3,500 points, that last goal is extremely important. And while here, near the end of the year, it might be too late to take advantage of all these tips for 2017, I hope they will help you in planning to hold onto as much of your nest egg as possible in 2018.
Reduce Your Investment Taxes, Tip #1: Tax Harvesting
This is the process of offsetting capital gains with capital losses, or selling your losers to reduce the tax hit that you will take by the winners you have sold. If you have held onto a stock that just hasn’t performed as you anticipated, or you want to rebalance your portfolio, now is the time to cut your losses and sell the losers for a possible tax advantage.
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Reduce Your Investment Taxes, Tip #2: Loss Carry-Forwards to Offset Ordinary Income
In the same vein, if you are holding a portfolio with several losing stocks, and the rest of your portfolio has given you some very nice gains, you may decide to ‘bite the bullet’ and unload all the nonperformers. The IRS also allows you to offset ordinary income by using up to $3,000 of your excess loss. And if you have more losses than $3,000, you may carry them forward in future years. But please remember the IRS wash-sale rule, which requires that you wait 30 days after selling a losing stock before you can buy it back at the discounted price.
Reduce Your Investment Taxes, Tip #3: Don’t Trade as Much
Every time you cash in a stock for a profit, you generate a capital gain. If you hold a stock for less than a year, you will be socked with a short-term gain, taxed as ordinary income. But if you keep it for longer than a year, your gain will be taxed at the lesser capital gains rate (around 15% for most investors, depending on your tax bracket).
Reduce Your Investment Taxes, Tip #4: Take Advantage of Tax-Deferred Accounts
I’m sure that most of you are well aware that investing in a tax-deferred account, such as a 401(k), 403(b), a SEP plan (for business owners) or IRA, allows you to stockpile your savings and defer payment of taxes on your dividends, interest or capital gains until you withdraw money from the account. But as you gather with your family for the holiday season, it’s a prime time to discuss this major tax advantage with your younger family members.
While the ‘spend now, pay later’ set may want to ignore your words of wisdom, they may pay more attention to this scenario painted by Fidelity.com, depicting the value of saving $10,000 a year for 25 years in a taxable account, a traditional tax-deferred 401(k), and a traditional tax-deferred 401(k) with an annual match of $3,000. (This scenario assumes a 7% annual return.)
Reduce Your Investment Taxes, Tip #5: Allocate Your Assets to the Right Accounts
Your investments that generate the highest taxable income—assets such as high turnover mutual funds or Real Estate Investment Trusts (REITs), and taxable bonds—may be best-suited for accounts that provide tax advantages, such as 401(k)s and IRAs. Alternatively, assets like munis, stock index ETFs, and long-term equity holdings—where taxes are minimized—would be better served in a taxable account.
I hope you can take advantage of some of these ideas to help you keep more of your money and pay less to the government, and from my home to yours, I wish you a Happy Thanksgiving.
Nancy Zambell, Editor of Wall Street’s Best Investments, has spent 30 years helping investors navigate the minefields of the financial industry. Nancy scours more than 200 advisories and research reports to select the top recommendations, which she collects for you in this easy-to-read digest.Learn More