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 free. Show all posts
Showing posts with label tax free. 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.
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