It’s that time of year again – tax season, and for many of us, we focus so much of our time on what types of investments we should have. We fail to think of HOW that money should be invested. Or more importantly in the month of April, how to minimize taxes on our investments!
If this has got you worried, it’s going to be okay. I’ve got a few simple strategies that will leave you with a lot more money in your pocket come May 1st.
Before we dive into these strategies, let’s be sure that everyone understands there are three basic formats to invest your money.
1. When you earn money, you can pay taxes on it and invest your money.
2. Before you receive your money, you can invest it pre-taxes in things such as a 401K.
3. Take your money, pay your taxes, and then invest it in a vehicle where it is going to grow tax free (e.g. Roth IRA).
Now that we are clear on the three forms of investing, let’s bring on those minimizing strategies.
Low Turnover Funds
If you’re considering investing your money into a mutual fund, be sure to check out the turnover percentage. If you’re finding numbers as high as 200%, that should be a red flag for you. Knowing that this fund has a manager who is actively buying and selling leads to higher turnover percentages which creates higher capital gains. The more capital gains you have, the more taxes you pay. Therefore you’re better off looking for a low turnover/passive fund, or index fund, that does less buying and selling, which is going to minimize your taxes.
Minimize Capital Gains
No matter where you put your money, we hope it’s making you more! Which means you’re going to have capital gains. Although how do you minimize them so that your taxes don’t explode? Turn your capital gains, or dividends, into qualified dividends. Qualified dividends are max taxed at 20%... which is a steep drop for the 37% taxation you could experience on your capital gains if you’re in the top income bracket.
Invest in Lot Identification
This isn’t a process I’d recommend you take upon yourself. If you purchased stock in a company at multiple times over the course of the year, then this may be a strategy for you. Using a fine tooth comb, or an advisor with software, lot identification ensures that you’re selling the stocks you bought at a higher price first. For example, if you bought Apple shares at $100, and at $150, and they’re now worth $200, we would sell your $150 shares first because this will decrease your capital gains. This may sound simple enough when you’re dealing with one stock, but through an entire diversified portfolio… this may be a strategy best left to experts.
Tax Loss Harvesting
If you purchase a stock this year, and it’s currently sitting at a loss, this is an important strategy for you. By selling this stock now, you will “harvest” or realize the loss, which will work against your capital gains tax liability. If you’re dead set on owning this stock regardless of the current loss, you can always move your investment to a new index, and then after 30 days and fully realizing the loss, you can repurchase the same amount of the index.
Distribution strategies become important when you’re a retiree. This involves drawing from specific accounts in order to reduce your tax bracket throughout your retirement. Having a variety of funds from 401(k)s to Roth IRAS and Social Security make this possible.
While getting taxes upfront goes against everyone’s thought process, if you expect to be earning more when you’re in retirement than you do currently, it can be advisable to pay the taxes and focus on filling up those Roth IRAS.
So as you can see, there are a variety of strategies for you to minimize your taxes. If you’re taking the time every year to look at what your investments are doing and how you can be investing to minimize taxes, it will impact your annual bottom line. Each year you apply tax minimizing strategies to your taxes, the amount you're saving is going to add up to what could be thousands, if not millions of dollars over your lifetime.
At Heller Wealth Management, we work to keep your money in your pockets.