Start looking for ways to lessen investment taxes
Like millions of your fellow citizens, you may have recently filed your taxes. If you think that things might have turned out differently had you paid less in investment-related taxes, you might want to take steps soon to help ensure a different outcome in 2011.
Here are some “tax-smart” strategies to consider:
4 Invest in municipal bonds. If you’re in one of the upper income brackets, you might benefit from owning municipal bonds. The interest payments from “munis” are typically exempt from federal income taxes, and may also be exempt from state and local taxes, depending on where you live. (However, the interest from some types of munis may be subject to the alternative minimum tax, or AMT.)
4 “Max out” on your Roth IRA. If you qualify for a Roth IRA, try to fully fund it every year. Your earnings grow tax-free, provided you’ve had your account at least five years and you don’t take withdrawals until you’re at least 59-1/2. And now, it’s easier to convert a traditional IRA to a Roth IRA. Under previous rules, you could only convert if your modified adjusted gross income (MAGI) was $100,000 or less. But starting this year, you can convert funds to a Roth IRA even if your MAGI is over $100,000. And if you convert in 2010, you can report the taxable income from the conversion over a two-year period, in 2011 and 2012.
4 Distribute assets between taxable and retirement accounts. You’ll want to look at all your investments as a whole to determine if they’re working together to help you achieve your goals. But in considering ways to control investment taxes, you may also find it useful to look at two separate categories: your tax tax-deferred retirement accounts, such as your traditional IRA and your 401(k), and your taxable accounts, which hold all the investments not in your retirement accounts. As a (very) general rule, you might want to put income-producing securities, such as taxable bonds, into your tax-deferred retirement accounts. When you ultimately take out this money, presumably at retirement, your withdrawals will be taxed at your income tax rate, but by then, you may be in a lower tax bracket. Conversely, you may want to put growth-oriented securities, such as stocks, in your taxable account; as long as you hold these assets at least a year, you’ll only have to pay the long-term capital gains rate, which is currently 15 percent if you’re in one of the top three tax brackets. (This rate may soon rise, however.)
4 Sell your “losers” throughout the year. If you own investments that have lost value and that you don’t need to keep for other reasons (such as portfolio balance), consider selling them throughout the year. Your losses can offset any capital gains you might have achieved; if you don’t have any gains, the losses can offset up to $3,000 of your regular income. Plus, any losses that you don’t use in a given year can be carried forward indefinitely for use against future capital gains.
Before embarking on any of these strategies, consult with your tax advisor. Every “tax-smart” move may not be appropriate for your individual situation. But if you’re concerned about the impact of investment taxes, it can certainly pay to explore all your options.
Tommy McDonald is a financial advisor at Edward Jones in Natchez. He can be reached at 601-446-5666.