Last week I addressed tax-efficiency in your portfolios. Here I shall review the differences among those classifications of taxable, tax-deferred and tax-exempt to make tax-efficiency more readily understood. The following are simple explanations. For expert tax guidance please speak with your accountant or tax attorney.
Taxable: an account that holds money on which you have already paid taxes - e.g. bank checking or savings accounts or brokerage accounts. These accounts may have stocks, bonds, CD's, etc. Every year you receive a 1099 of all reportable earnings: dividends and interest as well as reportable proceeds: stock or bond sales. You enter these numbers on your tax return and pay taxes accordingly.
Tax-exempt: refers to bonds (loans) issued by municipalities (states, cities, towns, counties). These bonds are exempt from federal taxes. As an incentive to its residents to buy these bonds, which finance local projects, you pay no state taxes on the interest. As a NY resident, if you purchase a NY State bond, it will be double tax exempt as you will pay no state or federal taxes on the interest. However, NY reserves the right to tax the interest earned on other states' bonds.
Tax-deferred: means you pay no taxes now but when you withdraw the money both state and federal taxes are due. IRA, SEP, 401k, 403b all grow tax-deferred. Your 401k or 403b plan from work will take money from your paycheck before deducting taxes, deposit the money into your plan where it will grow tax-deferred (you will not receive a 1099 each year). Taxes will be paid when you start withdrawing money from these accounts later in retirement. The money will be taxed, as your income is taxed, both by the state and the federal government. Hopefully, in retirement you will be in a lower tax bracket and, consequently, pay less in taxes.
Tax-free: refers to a Roth IRA where money grows without paying taxes each year and is distributed without being taxed. Actually, the money contributed to most Roth IRA's is money on which you have already paid taxes; it is the earnings (growth) that are tax-free.
Be $ Smart - Learn about the impact of taxes on your investments. Position your assets effectively to pay less in taxes.
Showing posts with label tax exempt. Show all posts
Showing posts with label tax exempt. Show all posts
Sunday, April 15, 2018
Monday, April 9, 2018
Make Your Portfolios More Tax Efficient
We are in the midst of tax season so this is a good time to review your portfolio to make sure it is arranged in the most tax-advantaged way.
Most investments (bonds, bond mutual funds and ETF's) that generate interest work best in a tax-deferred account.
Muni bonds are an exception as their interest is exempt from federal taxes and in many cases, exempt from state taxes as well. Hold municipal bonds in your taxable accounts.
Stocks, usually long term investments, should be held in your taxable account for several reasons:
1. long-term capital gains on stocks are taxed at a maximum 20%. Most folks will pay less, 15%. That is certainly a better rate than 25% - 30% regular income as it would be taxed from an IRA or 401K distribution.
2. losses in your taxable account can be used to balance any gains you realize. Losses cannot be taken in a tax-deferred account.
3. qualified dividends from stocks are taxed at 20%. These same dividends in a tax-deferred account are added into the overall distributions and are taxed as ordinary income - 20% -37%.
4. you may donate stock that has grown significantly to charity avoiding any capital gains tax.
5. you may pass appreciated stock on to your heirs at your death. This will give them a step-up in basis (which means the cost basis of the stock - what you paid for it - will now be the value of the stock on the day you died.) If they sell the stock immediately there will be little or no capital gains tax.
Roth IRA's are different!!
All contributions to Roth IRA's are after tax.
Distributions from a Roth are tax-free, so holding both stocks and bonds in a Roth is fine. The one problem is that you may not take a loss on any stock that may have fallen in value.
Be $ Smart - be aware of how dividends, interest and capital gains are taxed so you may position your portfolios in the most tax-efficient way. You keep more money in your pocket and less in Uncle Sam's.
Most investments (bonds, bond mutual funds and ETF's) that generate interest work best in a tax-deferred account.
Muni bonds are an exception as their interest is exempt from federal taxes and in many cases, exempt from state taxes as well. Hold municipal bonds in your taxable accounts.
Stocks, usually long term investments, should be held in your taxable account for several reasons:
1. long-term capital gains on stocks are taxed at a maximum 20%. Most folks will pay less, 15%. That is certainly a better rate than 25% - 30% regular income as it would be taxed from an IRA or 401K distribution.
2. losses in your taxable account can be used to balance any gains you realize. Losses cannot be taken in a tax-deferred account.
3. qualified dividends from stocks are taxed at 20%. These same dividends in a tax-deferred account are added into the overall distributions and are taxed as ordinary income - 20% -37%.
4. you may donate stock that has grown significantly to charity avoiding any capital gains tax.
5. you may pass appreciated stock on to your heirs at your death. This will give them a step-up in basis (which means the cost basis of the stock - what you paid for it - will now be the value of the stock on the day you died.) If they sell the stock immediately there will be little or no capital gains tax.
Roth IRA's are different!!
All contributions to Roth IRA's are after tax.
Distributions from a Roth are tax-free, so holding both stocks and bonds in a Roth is fine. The one problem is that you may not take a loss on any stock that may have fallen in value.
Be $ Smart - be aware of how dividends, interest and capital gains are taxed so you may position your portfolios in the most tax-efficient way. You keep more money in your pocket and less in Uncle Sam's.
Saturday, July 9, 2016
Take Advantage of Your HSA
Health Savings Accounts are becoming more popular. They are usually part of a high deductible plan and are different from flex-spending.
They are triple-tax-advantaged where you pay no state or federal income tax on the money as it is deducted from your pay before taxes are calculated or
1. Contributions you make to a HSA are tax-deductible,
2. Contributions made by your employer are tax-free,
3. Interest accrued in the HSA is also tax-free,
and the accounts are “portable” meaning they stay with you even if you change jobs or leave the workforce.
Unlike flex-spending which must be used up annually (up to $500) or you lose it, HSA money can be carried forward indefinitely. This makes an HSA account another form of savings to use in retirement where healthcare can be a major expense.
Tax-free distributions from your HSA are made upon presenting receipts for qualifying health expenses like deductibles and co-pays. If you are able to cover these expenses out of pocket, you may hold on to the receipts and get a tax benefit in future years. Meantime, your money in the HSA grows tax-free.
Over time, If you are healthy and hardly draw from your HSA you could amass a sizable amount of money in your HSA to be used for future health expenses. There is no time limit on your receipts!
Be $ Smart - Save as much as you can in your HSA to take advantage of the triple tax exemptions. Use every tax break Uncle Sam offers. It leaves more money in your pocket!
They are triple-tax-advantaged where you pay no state or federal income tax on the money as it is deducted from your pay before taxes are calculated or
1. Contributions you make to a HSA are tax-deductible,
2. Contributions made by your employer are tax-free,
3. Interest accrued in the HSA is also tax-free,
and the accounts are “portable” meaning they stay with you even if you change jobs or leave the workforce.
Unlike flex-spending which must be used up annually (up to $500) or you lose it, HSA money can be carried forward indefinitely. This makes an HSA account another form of savings to use in retirement where healthcare can be a major expense.
Tax-free distributions from your HSA are made upon presenting receipts for qualifying health expenses like deductibles and co-pays. If you are able to cover these expenses out of pocket, you may hold on to the receipts and get a tax benefit in future years. Meantime, your money in the HSA grows tax-free.
Over time, If you are healthy and hardly draw from your HSA you could amass a sizable amount of money in your HSA to be used for future health expenses. There is no time limit on your receipts!
Be $ Smart - Save as much as you can in your HSA to take advantage of the triple tax exemptions. Use every tax break Uncle Sam offers. It leaves more money in your pocket!
Tuesday, April 14, 2015
Investment Diversification cont'd - Bonds
When you talk about diversification you hope to spread your money into a variety of investments. By doing so, you are given the opportunity to create the potential for your money to grow while you reduce the risk.
Last week we addressed stocks. This week we'll review the many facets of bonds.
Bonds come in many varieties - both taxable and tax exempt.
With a bond, you are lending your money; it may be to a corporation, a country or a municipality.
Corporate bonds are issued by companies, of all sizes. High grade corporate bonds from major corporations carry high ratings and the interest earned and distributed is taxable. Most high rated bonds are backed by collateral, e.g. inventory, buildings, property, machinery, etc. Because of their relative safety, they will pay a lower interest rate.
High yield corporate bonds pay a higher return because they may be less safe. The company may be having some financial difficulty and the bonds may be backed by a "promise to pay", not real collateral.
Governments issue bonds for many reasons to run their country. Our own U.S. Treasury offers several types of bonds. Sovereign bonds issued by governments outside the U.S. offer international diversification. Because of the solvency of each country, the risk and yield (return) will vary. You will pay taxes on the interest you earn on these bonds.
Municipalities like cities, states, counties, towns all have the ability to borrow money and issue bonds. Again, the solvency of the region will determine how safe your money may be and the interest each will pay. There are several agencies that rate these bonds. AAA is the highest all the way on down to NR, not rated. The U.S. government does not tax the income from these bonds - they are considered tax-exempt.
A bond issued by New York city would be triple tax-exempt to a resident of NYC. He would pay no city, state or federal tax on that bond.
For diversification you would want some taxable and tax exempt bonds.
You would use bonds of different countries as well as different municipalities.
Be $ Smart - use several different types of bonds when building a portfolio.
Bonds can be quite complex. This is a simplified overview.
Last week we addressed stocks. This week we'll review the many facets of bonds.
Bonds come in many varieties - both taxable and tax exempt.
With a bond, you are lending your money; it may be to a corporation, a country or a municipality.
Corporate bonds are issued by companies, of all sizes. High grade corporate bonds from major corporations carry high ratings and the interest earned and distributed is taxable. Most high rated bonds are backed by collateral, e.g. inventory, buildings, property, machinery, etc. Because of their relative safety, they will pay a lower interest rate.
High yield corporate bonds pay a higher return because they may be less safe. The company may be having some financial difficulty and the bonds may be backed by a "promise to pay", not real collateral.
Governments issue bonds for many reasons to run their country. Our own U.S. Treasury offers several types of bonds. Sovereign bonds issued by governments outside the U.S. offer international diversification. Because of the solvency of each country, the risk and yield (return) will vary. You will pay taxes on the interest you earn on these bonds.
Municipalities like cities, states, counties, towns all have the ability to borrow money and issue bonds. Again, the solvency of the region will determine how safe your money may be and the interest each will pay. There are several agencies that rate these bonds. AAA is the highest all the way on down to NR, not rated. The U.S. government does not tax the income from these bonds - they are considered tax-exempt.
A bond issued by New York city would be triple tax-exempt to a resident of NYC. He would pay no city, state or federal tax on that bond.
For diversification you would want some taxable and tax exempt bonds.
You would use bonds of different countries as well as different municipalities.
Be $ Smart - use several different types of bonds when building a portfolio.
Bonds can be quite complex. This is a simplified overview.
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