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Lower Your Tax Bill Through Tax Location

[/fusion_text][fusion_text]If a tree falls in the woods and nobody is there to hear it, does it make a sound? I say yes. If your portfolio return stays the same, but you have more money left after taxes, do you have a better return? Yes, but you may not recognize it. Your after-tax return, the money you keep after paying Uncle Sam, will be higher.

One easy way to improve your after-tax return is through proper tax location. Tax location is the process of looking at which investments are best held in which accounts based on tax status. Let’s focus on three basic types of accounts.

There is a traditional IRA/401k. You get to defer taxes on the money you contribute and any growth along the way. Then when you withdraw the money, you get taxed on it as income.

There is a Roth IRA/Roth 401k. You already paid tax on that money when you earned it. You do not pay any taxes as those accounts grow, nor do you pay any taxes when you pull the money out.

There is a regular taxable brokerage account. You pay taxes on the income and dividends along the way. You also pay taxes when you sell investments at a gain. If you hold those investments for more than a year, you get to use a lower long-term capital gains tax rate.

One simple way to improve your after-tax return is by putting the investments with the highest expected return in your Roth account. That growth will never be taxed again (under current tax law). Let’s maximize the growth here.

Once you have filled up your Roth account, put the next most aggressive investments in your regular taxable account. That at least gets to take advantage of the lower long-term capital gains tax rates.

Save your low growth investments, the ones you hold for stability (think bonds), for your traditional IRA/401k account. You are going to pay the highest tax rate you owe on money you pull out of that account.

Do you get the basic idea? Shoot for higher growth in the accounts with lower or no taxes due. Put the slow growth in the high tax rate accounts. Need help? Let me know.[/fusion_text][separator style_type=”single” top_margin=”” bottom_margin=”” sep_color=”” icon=”” width=”” class=”” id=””][fusion_text]

Legal Disclaimer: These posts do not constitute an offer or recommendation to buy or sell any securities or instruments or to participate in any particular investment or trading strategy. They are for informational purposes only. ASA gathers its data from sources it considers reliable. However, ASA makes no express or implied warranties regarding the accuracy of this information or any opinions expressed by the author and may update or change them without prior notification.