Importance of LGBT Tax Efficient Investing
When making investments, one should also think carefully about the tax effects of their investments. While actual returns on individual stocks and mutual funds are subject to the short-term volatility of the market, you have great control over levels of tax-efficiency in your investments. In short, one should make sure that the highest percentage of your investment return is leftover after taking out taxes. These decisions are a crucial aspect of LGBT financial planning due to the new tax complications of overturning DOMA and legalizing gay marriage in some states. Below are a few quick pieces of advice on tax efficient investing.
One first needs to determine the types of accounts they have when determining tax location. Some accounts, like individual bank accounts or joint investment accounts, you must pay taxes the year income is received. Theses are commonly referred to as taxable accounts Others are known as tax-deferred, meaning that you don’t have to pay taxes as long as you keep your money in the account. All retirement accounts, such as IRA’s, Roth IRA’s or 401k’s, are tax deferred. The general rule is that the tax-inefficient investments should be put tax-deferred accounts, while tax-efficient investments should be placed in taxable accounts.
Index Funds for Long Term-Capital Gains=Tax Efficiency
Generally speaking, index funds that are held over a long period of time are the most tax-efficient common investment around. The main reason for this is that index funds, unlike stock funds, do not usually have capital gains distributions on a regular basis. Capital gains distributions are income earned on your investment. If you are given a capital gain, then you must pay taxes on that profit. Furthermore, if you keep your low cost index-fund for more than one year, you pay much lower capital gains taxes. Short-term capital gains, those earnings gained in less than one year, can have a tax rate as high as 35%. Long-term capital gains, or earnings from investments held for more than a year, have tax rates that are usually around 15%. Therefore, a buy and hold strategy in investments that do not make regular profit distributions to shareholders can be the most tax efficient strategy.
Tax Loss Harvesting
Tax loss harvesting is a complicated term for a simple process. If one losses money on an investment, you can “write-off” the capital gains loss on your taxes. Specifically, capital gains losses can be used to offset up to $3,000 in earned income for a calendar year. For someone in the 25% tax bracket, this can lower your taxes by as much as $750. For people in higher tax brackets, harvesting tax losses can be an effective way to considerably lower taxable income.
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