Financial Literacy

Leave the Taxman in the Cold This Year

It’s almost that terrible time of year again.

That’s right. Tax time.

Of course, we have to pay taxes, but there are smart ways to minimize – legally of course – the amount we pay.

Below I detail five great ways to tax-manage your investments. It may be too late to use most of these tips to minimize 2019 taxes, but right now is the time to put them into action to cut your 2020 taxes.

First, stick to quality investments. If you’re investing in high-quality investments, you’ll have less churn in your portfolio and fewer trades. That means you’ll also pay less in capital gains taxes, which are not a tax on gains, but a tax on realized gains from transactions.

Second, hang on for 12 months. Remember that a gain from selling any investment (stocks, bonds, funds, exchange-traded funds and real estate) that you’ve owned for less than a year is considered a short-term capital gain. And those are taxed at regular income tax rates, which can be as high as 37%. Investments sold after being held longer than a year qualify as long-term capital gains, which are taxed at a maximum rate of 20%, and potentially 15% or 0% depending on your income.

Third, if you do have short-term capital gains, offset capital gains with capital losses. If there are investments that no longer fit your strategy and you need to sell them at a loss, you can offset some of your capital gains taxes with losses you incur. It’s also called tax-loss harvesting. It’s good tax management, and you can use it to deduct up to $3,000 per year against taxable income.

Fourth, avoid actively managed funds, which – if they trade a lot – are required by the government to distribute most of their realized capital gains each year. And if you’re in that fund, that could mean capital gains taxes for you. Worst of all, you might not be expecting these.

Finally, hold your high-yielding investments in a tax-deferred account like an IRA or a 401(k). These investments include bonds, utilities and real estate investment trusts. Why not use a tax-advantaged account to shield investment income from the IRS?

I always tell new Investment U employees that, while many of these tips may save you just a bit on taxes, the power of compounding makes them quite significant in the long run.

For example, if you use these tips to retain an additional 4% of your portfolio’s return each year – which is entirely doable – the difference could be as much as $419,000 over 20 years.

In addition to those investing-related tax strategies, here are a few others I’ve found to be big tax savers in the past…

The home office deduction. You may qualify for this one and not know it. If you’re a renter or homeowner and use a portion of your home for business, you can write off a portion of your regular home expenses, including rent, utilities, insurance and housekeeping. I used this deduction when I was self-employed and grew to love it.

Be careful, however. You need to check your eligibility. The IRS makes the guidelines very clear.

Open a health savings account (HSA). HSAs are a great deal. You can set aside pretax income into an HSA to cover any health-related costs that your insurance plan doesn’t cover. Think eyeglasses, medical devices, lab fees and other out-of-pocket expenses. When you withdraw from an HSA to pay for qualified expenses, that also isn’t taxed. And money put into an HSA doesn’t need to be spent that year – it rolls over to the next year and onward into the future. It also earns interest, and unused funds can be invested.

Let’s leave the taxman in the cold this year.

Enjoy your day,

Matt


About

Matt has worked as an editorial consultant to the International Monetary Fund, the World Bank, the Economist Intelligence Unit and other global macro-institutions. He wrote about markets and economics for U.S. News & World ReportBloomberg News and Investor’s Business Daily, among other publications. He also worked for several years as head of political economy for a Financial Times-owned macroeconomic consulting firm, advising hedge funds around the world. Matt’s claim to fame is that he’s interviewed two U.S. presidents and has spoken with five Federal Reserve Chairs from Paul Volcker through Jerome Powell. Matt also served as The Oxford Club’s Editorial Director for two years.

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