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How Taxes Effect Your Investments


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Taxes and Investments

investment taxes
A small portion of your time should be devoted to understanding how taxes effect the growth of your portfolio. By understanding how each investment is taxed you can save your self a huge percentage of your total portfolio that would be paid to taxes. When planning for your retirement, saving for a home, or investing to go on vacation taxes will eat into your total return if you don’t plan around them carefully. Today, I am going to discuss how different assets are taxed and how you can minimize taxes in your portfolio. Warren Buffet was quoted saying that it wasn’t fair he paid less taxes then the average american because all his income was from capital gains compared to income tax.

Investment Tax

Corporate Investments

Bonds – Bonds can generate income in 2 ways, interest and gains/losses. Interest gained from owning a bond is taxed in your personal income and is subject to state and federal taxes. Gains and losses from owning a bond is taxed by capital gains tax
Stocks – gains on stocks are taxed as capital gains. Capital gains tax is currently 20%.

Government Investments

Bonds, Notes, Bills – Interest earned on government treasury securities are free of federal taxes, but you still need to pay state taxes. Gains and Losses on Government securities are taxed by capital gains tax.
TIPS – Treasury inflation-protected securities interest and increases in principal are taxable by the federal government, but exempt from state and local taxes.

Forex

Commodities have an interesting tax consideration. For investors who trade forex daily their is a benefit called the 60/40 Rule. This rule is that 60% of the gains can be taxed as long-term gains and 40% as short-term gains. Since tax implications are much higher on short-term investments this can be very beneficial for forex investors.

Ways To Pay Less Taxes

Now that you know how each asset class is taxed we need to understand how we can minimize the total tax implications on your portfolio. Lowering your taxes can be accomplished in a number of different ways, and which way you choose will depend on your overall strategy, goals, and length of time on when you withdraw your investment to use the money.

Roth IRA and Traditional IRA

roth ira taxesA great way for investors to lower their overall tax implications from their investments is to establish IRA’s. Their are two main types of IRA’s a traditional IRA and a Roth IRA.

Roth IRA

A Roth IRA is taxed today to avoid future taxes when the money is withdrawn. This can be very beneficial for investors who generate large long-term growth in their portfolio. However, their are some obstacles when dealing with Roth IRA’s. First the money cannot be withdrawn for at least five years. If you withdraw the money before that period you will have to pay some taxes on the gains. The other obstacle is you can only deposit a limited amount of funds in your Roth IRA. Once your personal income exceeds this threshold you cannot continue to deposit to your Roth IRA.

Traditional IRA

A Traditional IRA can help you avoid paying taxes. By putting your money into a traditional IRA you can avoid personal income taxes on the money deposited to the account. This is extremely useful for a person who is just above their previous tax bracket. By depositing money into your IRA you can lower your personal tax implications. IRA deposits can be made as late as the first due date for the previous tax year and can be.

Cashing Out Losses

cashing out stock losses
Another option to lower your tax implications is to cash out losses to offset gains. You can then repurchase the securities. Cashing out losses can help your portfolio avoid unnecessary taxes on gains made throughout the course of the previous year.

Tax Free Investments

Tax free investments such as government bonds can make a great source of tax free revenue for your portfolio. These investments are still subject to local and state income taxes, but the federal income tax is avoided. Gains in the principal of the bonds can also be counted as long-term investments so you pay minimum amount of capital gains tax on your gains.

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