Many individuals use investing as one of the primary methods to ensure their future financial success. It can be beneficial to strategically arrange your investments in such a way that provides returns with as minimal of a tax burden as possible. Here are three ways to minimize taxes on your investments.
1. Think Long-Term
The U.S. tax code favors individuals who plan to hold their investments for at least a year. If you purchase a stock and hold it for less than a year your investment gains will be subject to taxation at your ordinary income rate. If you are in the highest tax bracket, a large portion (39.6%) of your investment gains will be taxed. If you purchase stock and hold it for at least a year, however you will be subject to long-term capital gains tax when that investment is sold. Tax rates on long-term capital gains range from 0% to 20% depending on your income level. Even if you are in the highest tax bracket, the tax on long-term capital gains will be no more than 20%. If you are a frequent investor, these tax savings can make a huge difference.
2. Utilize Tax-Sheltered Accounts
Retirement accounts, such as 401(k)s and various IRA plans, allow your investments to grow tax deferred. Withdrawals from these accounts are taxed at your ordinary income rate, which, for many people, will be lower in their retirement years than their working years. Roth IRA conversions may also be beneficial for some individuals who met the income requirements. Roth IRA contributions are taxed now but are tax-free upon withdrawal.
3. Watch Your Dividends
If your investments provide dividends, you will owe some tax on those dividends. If you hold any high dividend paying stocks or bonds in a taxable brokerage account, you will be taxed at your ordinary income rate every time you receive a dividend. You could minimize this tax by holding your investments long-enough to push them into qualified dividend status. Qualified dividends, like long-term capital gains, get taxed at a lower rate. To qualify, the IRS requires investors to hold the share for a minimum period of time. Common stock investors must hold the stock for more than 60 days during the 121-day period that starts 60 days before the ex-dividend date, or the date after the dividend has been paid. Holding period’s may differ per investment type, so be sure to see if your investment qualifies.