One of your portfolio’s largest expenses is probably taxes. One way to help keep your portfolio growing is to invest in a tax-efficient manner. Some suggestions include:

  • Contribute to your 401(k) plan:  Contributions are made on a pre-tax basis, so you don’t pay income taxes currently (Social Security and Medicare taxes are paid), and earnings grow on a deferred tax basis until withdrawn. In 2020, you can contribute a maximum of $19,500 to a 401(k) plan, although your contributions may be limited to a certain percentage of your pay to comply with nondiscrimination rules. Individuals over age 50 may be able to make an additional catch-up contribution of $6,500 in 2020. Many employers also match your contribution, so you get additional funds at no cost to you.
  • Make contributions to an individual retirement account (IRA): In 2020, you can contribute a maximum of $6,000, plus those over age 50 can make an additional $1,000 catch-up contribution. Investigate whether you’re eligible to participate in a traditional deductible RAA or a Roth IRA and then decide which option is best for you. While you can’t deduct your contributions to a Roth IRA, your earnings grow tax-free as long as you make qualified distributions from the IRA. With a traditional deductible IRA, your contribution is deductible on your current year income tax return, and earnings grow tax-deferred.
  • Carefully decide which investments to hold in tax-advantaged and taxable accounts: Gains from investments held in retirement accounts, such as 401(k) plans and traditional IRAs, are taxed at ordinary income tax rates when withdrawn, rather than the lower capital gains tax rates. It may make sense to hold investments that produce ordinary income or that you want to trade frequently in retirement accounts, and investments that generate capital gains in taxable accounts. But factors such as your investment period should also be considered.
  • Analyze the tax consequences before rebalancing your portfolio: Portfolio rebalancing is a taxable event that may result in a taxable gain or loss. In general, avoid selling investments from your taxable portfolio for reasons other than poor performance. Bring your asset allocation in line through other methods.
  • Consider municipal bonds or stocks generating dividend income if you are in a high tax bracket: Since municipal bond interest is exempt from federal (and sometimes state and local) income taxes, your marginal tax bracket is a significant factor when deciding whether to include municipal bonds in your portfolio. Thus, it would help if you determined how a muni bond’s yield compares to the after-tax yield of a comparable taxable bond.
  • Look into tax-advantaged ways to save for college: If you are saving for college, look at education savings accounts (eSAs) and Section 529 plans. The annual contribution limit to ESAs is $2,000. While you can’t deduct the contribution on your tax return, earnings grow tax-free as long as funds are used for qualified education expenses. With Section 529 plans, you can contribute up to $75,000 to a qualified plan ($150,000 if the gift is split with your spouse) in one year and count it as your annual $15,000 tax-free gift for five years. However, if you die within the five year period, a pro-rata share of the $75,000 returns to your estate. Distributions from 529 plans to pay qualified higher-education expenses are excluded from income.
  • Consider owning a home: Owning a home has significant tax advantages. Mortgage interest and property taxes can be deducted on your tax return. When you sell your home, you can exclude up to $250,000 of gain if you are a single taxpayer and up to $500,000 of gain if you are married filing jointly, provided the home was your primary residence in at least two of the preceding five years. You no longer have to purchase another home to qualify for the exclusion.

For more information, please contact Munn Morris today.

Municipal securities typically provide a lower yield than comparably rated taxable investments in consideration of their tax-advantaged status. Investments in municipal securities may not be appropriate for all investors, particularly those who do not stand to benefit from the tax status of the investment. Please consult an income tax professional to assess the impact of holding such securities on your tax liability.

As with other investments, there are generally fees and expenses associated with participation in a 529 plan. There is also a risk that these plans may lose money or not perform well enough to cover education costs as anticipated. Most states offer their own 529 programs, which may provide advantages and benefits exclusively for their residents. The tax implications can vary significantly from state to state.


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