7 Strategies For Lowering Investment Taxes
A friend of mine was recently complaining about a tax bill coming their way from the sale of investments. I joked that I would gladly pay his tax bill in exchange for his investment gains…he declined. Taxes are an inevitable part of investing but generally, it is a good problem to have since it means you made money. However, there are several strategies to consider to make sure you don’t pay more than your fair share to Uncle Sam.
While I write a lot about retirement accounts here, this article is solely focused on taxable investment accounts (i.e brokerage stock or mutual funds accounts, not IRAs or 401ks).
There are two primary ways that you pay taxes from investments.
(1) Interest and ordinary dividends while you own investments: For example, the interest a bond pays or the ordinary dividend a stock fund pays. Any additional interest and ordinary dividends will be taxed at your marginal tax rate. In the example below, the investor’s additional interest and ordinary dividends are taxed at 24%.
(2) Profit from investments when you sell and qualified dividends: Any additional capital gains are taxed at lower preferential treatment if you hold the investment for over a year. In addition, special qualified dividends from stock funds are taxed at this lower rate. In the example below, the investor’s additional capital gains or qualified dividends will be taxed at 15%.
In addition to the taxes listed above, a more recent change in 2013 to the tax law introduced an additional 3.8% Net Investment Income Tax (NIIT) on most investment income including dividends, interest, capital gains, and more if your income is over $250,000 married or $200,000 single.
With these three taxes in mind, below are seven different strategies to help reduce these taxes.
Have a long-term investment approach. If you sell an asset for a gain that you held for less than a year, you are taxed at higher rates – in this example 24% instead of 15%.
Time the sale of assets. If possible, sell assets when your capital gain tax rate will be lower, perhaps in retirement or between job changes.
Consider investing in more municipal bonds, which are federally exempt from taxes. However, keep in mind, that municipal bonds typically pay less interest than taxable bonds so they make the most sense for high-income households.
Invest more in stock funds that payout qualified dividends instead of ordinary dividends since the tax rate difference is substantial between the two. Generally, most US stock funds held for a minimum amount of time will be qualified and taxed at lower rates.
Invest more in growth companies that pay little in dividends in taxable accounts and more in value companies than pay dividends in IRAs or 401(k)s.
Accelerate deductions in years of high income like 401(k) contributions and charitable gifts.
Do Roth conversions during years of low income. This will result in higher taxes in that year but can significantly lower total lifetime investment taxes.
Whether one or more of these strategies makes sense for you depends on several factors including your income level, expected future income levels, your age, and more.
Thank you for reading,
Alex
This blog post is not advice. Please read disclaimers.