4 ways to tax protect your investment portfolio


Americans leave a lot of money on the table for the taxman.

Taxpayers who get large tax refunds have effectively given the federal government an interest-free year-round loan, for example. And investors who don’t make sure their portfolios are as tax-efficient as possible could lose more of their investment returns in taxes than necessary.

Over time, this lack of planning can easily cost an investor thousands of dollars.

While you don’t want to design your portfolio solely around the goal of minimizing taxes, certain tax-minimizing steps may fit naturally into your investment strategy.

Here are some simple strategies to consider.

1. Know your tax rates

Investments are not all taxed at the same rate.

Items such as real estate investment trusts and bond interest, for example, are taxed as ordinary income, reports Fidelity Investments.

For the 2021 tax year, this currently means they can have a tax rate of up to 37%, while long-term capital gains are generally capped at 20%. (These numbers could also increase if President Joe Biden gets his wish to restore the top tax rate to 39.6%.) They may even go slightly higher for very high earners or those who sell items. collectibles such as coins or art.

This may affect the type of investments you choose and where you keep them, but it should also allow you to keep an eye on your income.

If you’re on the edge of a tax bracket, some financial decisions could push you over the edge. If you know this, you can aim to land on the side that best suits your situation and what you expect in the future.

2. Choose your tax shelters wisely

Think of tax-advantaged accounts such as 401(k) plans, Individual Retirement Accounts (IRAs), and Health Savings Accounts (HSAs) as boxes you can invest in. were left sitting on a table in the open air.

This is why they are often called “tax-advantaged” or “tax-sheltered” accounts.

However, different types of tax-advantaged accounts offer different types of tax benefits. And depending on your situation, one benefit could save you more taxes than another.

In other words, you can exercise some control over how your investments are taxed by choosing carefully where you keep your investments.

Take traditional and Roth accounts, for example.

When you contribute, for example, to a traditional IRA or a 401(k), you aren’t taxed on the money in the account when you deposit it. Instead, the money in such an account – both your initial contribution and the income it generates – is taxable later in the tax year in which you remove account money.

This fact often makes traditional accounts more attractive to people who expect to have lower income in the years they withdraw from the account than in the years they contribute to the account.

In contrast, money you deposit into a Roth IRA or 401(k) is taxed in the tax year for which you to pay the money. So if you follow the IRS rules for retirement account withdrawals, you can withdraw contributions and earnings tax-free.

This fact makes Roth accounts attractive to people looking to avoid tax in retirement, for example.

3. Know when to cut your losses

Nobody wants their investments to lose money, but maybe you can use the losses to your advantage.

Capital losses can be used to offset capital gains to the extent that you can use net capital losses to reduce your taxable income. The IRS explains:

“If your capital losses exceed your capital gains, the amount of excess loss you can claim to reduce your income is the lesser of $3,000 ($1,500 if married and subject separately) or your net loss total shown on line 21 of Schedule D (Form 1040). Claim the loss on line 6 of your Form 1040 or Form 1040-SR.

If your net loss is greater than this, you may be able to carry the excess loss forward on future tax returns.

This is called “tax loss harvesting”. Ideally, you’ll eliminate investments that no longer fit your investment strategy, appear to have poor long-term prospects, or leave your portfolio unbalanced.

Don’t prune investments just because you have seller’s remorse about them. And don’t give up on an investment because you think you can take a loss on paper before you buy it back. You can go against the IRS’ “worthless sales rule” and lose the deduction instead.

4. Be charitable

Charitable deductions are increasingly difficult to obtain as the standard deduction doubled in 2018; more taxpayers are choosing this deduction over itemizing deductions such as charitable donations. The IRS only allows you to do one or the other.

However, the coronavirus pandemic has temporarily changed things and some charitable tax breaks have been extended for 2021, which may make it easier for charities to claim a deduction.

If you don’t have enough deductions to make the itemization worthwhile, you may be able to counter this change by making multiple years of planned giving in a single tax year. So let’s say you want to donate $1,000 a year to charity. Instead, you would donate $2,000 and take the deduction every even year, then donate no odd year.

Also, instead of selling stock to get money for a charitable donation, it makes sense to donate the stock itself if you’ve owned it for more than a year. The charity does not have to pay the capital gains tax that you would pay, so you are not paying one tax to reduce another. The donation also goes further instead of being hijacked by Uncle Sam.

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