Insights & Ideas

Tax-Smart Investment Strategies

For many, ultimately it isn't necessarily what you earn that counts —it's what you keep. Taxes are inevitable, but long-term, tax-smart investing strategies may help you keep more of what you earn.

For many investors, it isn't what you earn that counts — in the end it’s what you keep that matters. While taxes are inevitable, there are a number of long-term, tax-smart investing strategies that may help you keep more of what you earn.

Our Top Ten Tax Tips

1. Before buying or selling an investment, understand the tax implications.
2. When shopping for a fund, look at its portfolio turnover rate.
3. Consider tax-managed funds, index funds, or funds that follow a buy-and-hold strategy.
4. Take full advantage of tax-deferred investment vehicles.
5. Pay attention to the type of investments you select for your tax-deferred and taxable     accounts.
6. Consider taxes when purchasing bond funds, even municipal bond funds.
7. Be aware of a fund's annual distribution date.
8. Manage your gains as well as your losses.
9. Talk to a tax advisor about tax-loss selling.
10. Beware of the Alternative Minimum Tax (AMT).

Strategies to Minimize Taxes and Get the Most from Your Investments

While we are happy to review some tax-smart investment strategies, it’s important that you consult your tax advisor before making investment decisions in an effort to lower your tax bill and enhance your after-tax returns.

Choose the Right Type of Investment

Some investments are taxable, some tax-free, some tax-deferred, and some tax-efficient. It’s important to make sure you are choosing the right type of investment for various accounts. Investments that generate taxable income, such as taxable bond funds or stock funds, may be better held in tax-deferred accounts — such as your IRA. Save the municipal bond funds or tax-sensitive investments for your regular, taxable accounts.

Then, make sure you're taking full advantage of tax-efficient investments. For instance, municipal bond funds generate income that is free from taxation at the federal level and, in some cases, the state and local levels as well. Other tax-smart investments include tax-sensitive mutual funds, and index funds or Exchange Traded Funds (ETFs), which typically utilize a buy-and-hold strategy.

Tap the Power of Tax Deferral

Tax deferral simply means that you postpone the payment of taxes until a later date — usually when you withdraw your money. This keeps your money working, and earning more, rather than going to pay taxes each year. It may not seem like much, but it can make a big difference in helping you achieve your financial goals.

There are a number of tax-deferred savings vehicles available to you as an investor, such as IRAs, 401(k)s, 403(b)s, and 529 plans. Remember, you will be subject to taxes at the time you withdraw assets from a tax-deferred account.

Tap the Power of Tax Deferral

Save for Tomorrow, Today

Retirement may seem far away, but starting early is crucial. Even if you can only save a small amount each year, you'll be better prepared to live comfortably in retirement. If you wait, you'll have to save much more each year in order to save the same amount and have enough money to retire at the age you'd like. Here’s a brief look at some of your retirement saving options.

Save for Tomorrow, Today

  • Company plans: If you are eligible for an employer sponsored retirement plan, such as a 401(k) or 403(b), sign up as soon as possible and try to contribute the maximum allowed to the plan, or at least enough to take advantage of your employer's matching contributions, if available.

  • IRAs: As long as you or your spouse has income from work, you may be eligible to contribute to an IRA. And depending on whether or not you have a company-sponsored plan, those contributions may be tax-deductible. Regardless, all earnings will grow tax-free.

  • Annuities: An annuity may be right for investors who aren't eligible for a traditional IRA or a Roth IRA. This alternative retirement investment offers tax-deferred growth during the accumulation phase with a wide range of investment options.

  • SEP IRA for small business owners: Small business owners, or employees of a small business, might consider a SEP IRA. Sole proprietors can contribute up to 20% of their profits from self-employment, and owners of incorporated businesses can contribute up to 25%. For employees contributions to SEP-IRAs are treated the same as an IRA.

An early distribution from a traditional IRA prior to age 59½ may be subject to a 10% excise tax penalty. A 10% federal income tax withholding feature (and any applicable state withholding) may also apply. Please consult your tax advisor to determine if an IRA is a suitable investment for you.

Manage Your Gains, and Losses

Make sure you are aware of a fund’s annual distribution date. If you buy shares right before capital gains are distributed, you will receive a distribution and have to pay tax on gains earned throughout the entire year, even though you are a new investor.

Further, when it comes time to sell, you may, or may not, wish to wait for distributions to be made. This will depend on the size of the gain, whether or not you are selling at a loss, and your tax strategy.

If you have investment losses, you may be able to offset them with your investment gains each year. Tax-loss harvesting can help reduce your income tax liability, particularly for investors in the highest income tax brackets. In fact, if your losses exceed your gains, you might also be able to offset up to $3,000 in earned income.

Beware of the AMT

The Alternative Minimum Tax (AMT) was created in the late 1960s to prevent very wealthy people from living tax-free. However, because it was never indexed for inflation, many middle-income taxpayers are finding that they also owe the AMT — particularly if one or more of the following apply:

  • Several children
  • Interest deductions from second mortgages
  • Interest from specified tax-exempt private activity bonds
  • High state and local taxes
  • Realized gains on incentive stock options

If you are already affected by the AMT, or are close to it, speak with a tax advisor or other professional to find out what steps you can take for better AMT planning.

Transfer of Wealth

For taxpayers who itemize their deductions, there may be a way, if appropriate to write off your charitable gifts. Instead of giving cash to your favorite charity, consider donating stocks that have substantially appreciated in value. This way, the cost of your donation is the lower, original purchase price, but you can deduct the higher, current market value of the stock — and you won't be hit with any capital gains taxes.

Investors should consider the investment objectives, risks, charges, and expenses of a mutual fund carefully before investing. Download a prospectus, or summary prospectus, if available, that contains this and other information about a fund, and read it carefully before investing.