April 24 has been designated Tax Freedom Day for 2015. Tax Freedom Day, calculated by the Tax Foundation, is the day when the nation as a whole has earned enough money to pay off its total tax bill for the year. So it may be a good time to review your own situation to determine if you can “free” yourself from some investment-related taxes in the future.
Of course, Tax Freedom Day is something of a fiction, in practical terms, because most people pay their taxes throughout the year via payroll deductions. Also, you may not mind paying your share of taxes because your tax dollars are used in a variety of ways — such as law enforcement, food safety, road maintenance, public education and so on — that, taken together, have a big impact on the quality of life in this country. Nonetheless, you may well want to look for ways to reduce those taxes associated with your investments, leaving you more money available to meet your important goals, such as a comfortable retirement.
Fortunately, it isn’t really that difficult to be a tax-conscious investor, as some of the best retirement-savings vehicles have built-in tax advantages. For starters, depending on your income level, your contributions to a traditional IRA may be tax-deductible, so the more you put in (up to the maximum of $5,500, or $6,500 if you’re 50 or older), the lower your annual taxable income. Plus, your earnings grow on a tax-deferred basis.
If you meet certain income guidelines, you may be eligible to contribute to a Roth IRA. The contribution limits for a Roth IRA are the same as those for a traditional IRA, but the tax treatment of your earnings is different. In fact, your Roth IRA earnings can grow tax free, provided you don’t take withdrawals before 59½ and you’ve had your account at least five years. (Roth IRA contributions are not tax-deductible, however.)
Even if you have an IRA, you can probably also participate in your employer-sponsored retirement plan, such as a 401(k), a 403(b) or a 457(b). You typically contribute “pretax” dollars to these types of retirement plans, so your contributions will lower your annual taxable income. Plus, you’ll benefit from tax-deferred earnings. And employer-sponsored plans have much higher contribution limits than an IRA; in 2015, you can put in up to $18,000 to a 401(k) or similar plan, or $24,000 if you are 50 or older.
Beyond contributing as much as you can afford to tax-advantaged retirement plans, how else can you take greater control of your investment-related taxes? One move is to avoid frequent buying and selling of investments held outside your IRA and 401(k). If you sell investments that you’ve held for less than one year, your profit will be taxed as ordinary income, with a rate as high as 39.6%. But if you hold investments at least one year before selling them, you’ll just pay the long-term capital gains rate, which is 15% for most taxpayers (20% for high earners). So, from a tax standpoint, it pays to be a “buy-and-hold” investor.
Taking full advantage of your IRA and 401(k) and holding your investments for the long term aren’t the only tax-smart moves you can make — but they can give you a good start on making investing less of a “taxing” experience.
Edward Jones, its employees and financial advisors cannot provide tax or legal advice. You should consult your attorney or qualified tax advisor regarding your situation.
Craig Johnson, AAMS®
513 Oak Avenue
Sulphur Springs, TX 75482