William Caughey, Financial Advisor
We’re getting closer to April 15: Tax Filing Day. And while there may not be much you can do to change your results for the 2014 tax year, you can certainly look closely at your tax returns to find areas you might be able to improve next year — and one such area is your investment portfolio.
Of course, you may also find opportunities in other places, too. Could you have taken more deductions? Could you have moved some of your debts into a tax-deductible loan, such as a home equity loan or line of credit? You’ll want to consult with your tax advisor to determine areas of potential savings.
However, you may be able to brighten your tax picture by making some “tax-smart” investment moves, such as the following:
- Resist the urge to trade frequently. It can be costly to constantly buy and sell investments. In addition to the commissions you may incur, and the possibility that such excessive trading can impede a consistent investment strategy, you could rack up a sizable tax bill. If you sell an asset that you’ve held for a year or less, any profit you earn is considered a short-term capital gain, which is taxed at the same rate as your ordinary income. So, for example, if you bought Investment ABC for $1,000 on January 5, 2014, and you sold it for $1,250 on Dec. 31, 2014, you’d be taxed on your $250 gain. If you are in the 28% tax bracket, you’d owe $70 in taxes. But if you had waited until January 6, 2015, and you sold your investment for the same $250 gain, you’d pay the more favorable long-term capital gains tax rate of 15%, which translates into $37.50 in taxes — just over half of what you’d owe at the short-term rate. If you habitually sold investments after owning them less than a year, the taxes could really add up —so try to be a “buy-and-hold” investor.
- Increase your 401(k) contributions. If you aren’t already participating in your 401(k) or similar plan, start now. And if you are contributing, boost your contributions whenever your salary goes up. You typically put “pretax” dollars in your 401(k), so the more you add, the lower your annual taxable income. Plus, your earnings can grow tax deferred.
- “Max out” on your IRA. Depending on your income level, you may be able to deduct some, or all, of your contributions to your traditional IRA — and these deductible contributions can lower your taxable income. Plus, your investment can grow tax deferred. (Keep in mind, though, that taxes will be due upon withdrawal, and any withdrawals made before you reach 59½ are subject to a 10% IRS penalty.)
If you contribute to a Roth IRA, your contributions are never deductible and won’t lower your taxable income, but your earnings are distributed tax free, provided you’ve had your account at least five years and you are older than 59½. In 2015, you can contribute $5,500 to your IRA, plus an additional $1,000 catch-up contribution if you are 50 or older— and it’s almost always a good idea to “max out” your contributions each year.
By following a buy-and-hold investment strategy and using those tax-advantaged accounts available to you, you may be able to help yourself — at tax time and beyond.