Tax-Saving Strategies for Investors

Uncle Sam will always take their share, but with strategic investment planning, you can limit his impact. By placing funds in tax-efficient accounts and strategically positioning assets to reduce tax liability.

Tax strategies that defer or reduce federal income taxes can result in greater total returns when withdrawing funds later. Here are four approaches you can use to manage, defer, or reduce federal income tax liability.

1. Use Tax-Advantaged Accounts

Taxes should never dictate your investment decisions; however, taking an analytical approach could help reduce your tax bill by selecting asset classes and accounts to hold them in. Retirement savings accounts, like 401(k), 403(b)s and IRAs as well as tax-deferred annuities may offer valuable protections from Uncle Sam.

Hold investments with significant annual ordinary income, like bonds and bond funds, in tax-advantaged accounts to limit how much in taxes you owe. And consider regularly rebalancing your portfolio as another means of mitigating tax costs.

These strategies provide some ways to increase after-tax returns and work towards financial freedom. Working with a trusted financial professional is crucial when investing to develop and execute an overall plan that manages, defers or reduces federal taxes *Source: Investopedia

2. Hold Bonds in Taxable Accounts

Taxes don’t need to be an inhibitor to returns; with careful choices and an intelligent tax plan in place, investors can minimize Uncle Sam’s share.

As part of your first steps toward investing, determining your risk tolerance and allocating assets are critical first steps in creating an investment portfolio that’s tax-efficient.

As a general rule, it is usually wise to utilize tax-advantaged accounts (such as traditional 401(k), 403(b) or IRA) prior to adding funds into taxable accounts. This way you’ll avoid creating an taxable event when selling assets within tax-advantaged accounts and repurchasing them in your taxable account.

Consider asset location by sorting through your assets to distinguish the “wheat” from the “chaff.” For example, holding total stock market index funds in your taxable account and municipal bond funds in tax-deferred accounts could help lower taxes; however, such an approach requires an in-depth knowledge of expected returns for both types of investment classes.

3. Invest in Tax-Advantaged Annuities

While optimizing investment returns is paramount, investors should not neglect to minimize taxes. Thankfully, strategies to help limit tax liabilities are accessible to almost everyone regardless of income level or time until retirement.

Investment in tax-deferred annuities allows interest to accrue without paying federal (and in many cases state) income tax until withdrawals are made compared with investing in ordinary income rate funds which tax at ordinary income rates; this can significantly accelerate savings growth and boost after-tax income during retirement.

Low-cost variable annuity wrappers, competitive guaranteed return levels for fixed annuities and longevity-risk benefits make annuities an appealing alternative to holding bonds in taxable accounts, providing advisors an opportunity to educate clients on ways to make retirement savings more tax efficient and increase after-tax income in retirement. Successful tax management can ultimately be one of the best strategies for outpacing market returns over time.

4. Donate Appreciated Securities

Donating appreciated securities – stocks, bonds and mutual funds – to charity may significantly boost both your contribution and tax deduction. By giving directly rather than selling first and donating the after-tax proceeds after taxes have been taken out, capital gains taxes are avoided while an income tax deduction for their full fair market value can be claimed against income taxes.

Imagine you purchased 1000 shares of publicly traded stock XYZ five years ago for $5,000 and now it trades at $7,000. If you sold and donated the net cash proceeds, capital gains tax might apply; but by giving the stocks directly to a public charity instead, capital gains taxes are legally avoided, while more money stays with the charity instead of going directly to IRS as taxes. This strategy can maximize the impact of your giving efforts and make giving more powerful.

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