For high-income earners, taxes can seem like a constant drain on their hard-earned investment returns. However, with the right strategies, you can minimize your tax burden and keep more of your money working for you. Armed with tax-smart investment techniques, you’ll be able to grow your wealth more efficiently and master the art of minimizing taxes.
Let’s discuss five essential strategies to turn you into a tax-smart investor.
Embrace the Benefits of Tax-Advantaged Accounts
First, let’s talk about tax-advantaged accounts like 401(k)s, IRAs, and 529 plans. These accounts can be a real game-changer when it comes to saving on taxes while investing for retirement or education expenses. Make sure to balance contributions to these accounts and your other investments to maximize tax savings.
To determine the optimal mix, consider your financial goals, income level, and tax situation. By prioritizing contributions to tax-advantaged accounts, you can take advantage of tax-deferred or tax-free growth and potential employer matches or state tax benefits. Remember, though, that some of these accounts have annual contribution limits and income restrictions. Regularly reevaluate your contributions and adjust as needed to ensure you’re making the most of the available tax benefits.
Capital Gains Management
Now, let’s dive into capital gains. It is essential to understand the difference between short-term and long-term capital gains and how they impact your tax bill. Short-term capital gains occur when you sell an investment held for one year or less and are taxed at your ordinary income tax rate. On the other hand, long-term capital gains result from selling assets held for more than a year and are taxed at more favorable rates, typically 0%, 15%, or 20%, depending on your income level.
Remain mindful when you sell your investments to optimize your tax situation and keep more of your returns. For example, consider holding onto investments for over a year to qualify for the lower long-term capital gains tax rate. Additionally, suppose you’re in a lower income tax bracket for a particular year. In that case, you might take advantage of the 0% long-term capital gains rate by strategically selling some of your appreciated assets.
Sometimes, investments don’t work out the way we hoped. But don’t worry—tax-loss harvesting can help you turn those lemons into lemonade! By strategically selling underperforming assets, you can use those losses to offset capital gains or reduce taxable income, minimizing your tax liability. When you sell an investment at a loss, you can use that loss to offset any capital gains you may have realized during the year. If your losses exceed your gains, you can also use up to $3,000 of those losses to offset your ordinary income, with any remaining losses carrying forward to future years.
One crucial point to remember when using tax-loss harvesting is to avoid the “wash-sale” rule. The IRS disallows the loss deduction if you buy a “substantially identical” security within 30 days before or after the sale of the investment that generated the loss. To stay compliant with this rule, consider reinvesting the proceeds from the sale into a different but similar investment to maintain your desired asset allocation without violating the wash-sale rule.
Selecting Tax-Efficient Investments
Choosing appropriate investments is crucial for tax-efficient investing. Tax-managed funds and low-turnover index funds can minimize taxable distributions, allowing you to keep more of your hard-earned returns. Tax-managed funds are designed to minimize taxable distributions by actively managing their portfolios to reduce capital gains and other taxable income. On the other hand, low-turnover index funds have a more passive approach and tend to have lower turnover rates, resulting in fewer taxable events.
In addition to selecting the proper type of funds, it’s necessary to consider the tax implications of individual investments. Some investments, such as municipal bonds, generate tax-free income at the federal and state level. Others, like stocks and mutual funds, may be subject to different tax rates depending on factors like holding periods and dividend reinvestment.
Make Your Charitable Giving Tax-Smart
Generosity always has its rewards! By donating appreciated assets or utilizing donor-advised funds (DAF), you can maximize your tax deductions while supporting causes close to your heart. Donating appreciated assets, such as stocks or mutual funds held for more than a year, can be an excellent way to give back while avoiding capital gains taxes on the appreciation. By donating these assets directly to a qualified charity, you can receive a charitable tax deduction for the full fair market value of the donation, up to 30% of your adjusted gross income (AGI). Donating appreciated assets can also help diversify your portfolio and rebalance your holdings.
When it comes to charitable giving, it’s essential to work with a reputable charity and consult with your financial advisor or tax professional to ensure you’re taking full advantage of the available tax benefits. With the right strategy, you can give back to your community while also minimizing your tax liability and maximizing your charitable impact.
Individuals can efficiently manage their wealth while making a lasting impact on the world. By embracing tax-efficient giving methods, investor’s are able to use one’s financial success to benefit others and create positive change. From maximizing tax-advantaged accounts to utilizing tax-loss harvesting and selecting tax-efficient investments, there are numerous ways for savvy investors like you to minimize your tax burden and keep more of your money working for you.
At Uncommon Cents Investing, we’re proud to provide our community with high-quality investing strategies and retirement planning help. And because we understand the unique challenges and opportunities facing high-income earners, we’ll be honest with you if you’re doing something that will derail you from achieving your goals! Contact us today for an introductory call!