Smart investing is all about finding the right place to put your money at the right time, right? Well, not exactly. If this is your approach, you’re missing out on a key component of your money management strategy, and you’re probably losing a great deal of your earnings to the tax man. While timing your investments wisely and putting them in the right place is important, the accumulation of capital is only one piece of a larger puzzle. Equally important are the preservation and distribution strategies for the wealth you’ve worked oh-so-hard to build. If you’re asking yourself “what are preservation and distribution strategies, and where can I get some?” you owe it to yourself to keep reading.
One of the most important pieces of your investment strategy involves minimizing the impact of taxation on your various investments in order to retain as much of your hard-earned savings as possible. This can be done by leveraging tax-deferred savings accounts like IRAs and Indexed Universal Life insurance policies (IULs), as well as carefully timing when and how much money you move around. Here are five things you can do to make sure you retain as much of your investment savings as possible.
1) Use Required Minimum Distributions (RMDs) to your advantage:
When you turn 70 ½, the IRS requires that you begin taking disbursements from your retirement accounts, whether you need it or not, so they can soak up that good old tax revenue. When that time comes, be sure to include RMDs as part of your planned income to avoid an additional tax burden, ensuring that the distribution phase of your retirement strategy is as tax efficient as possible.
2) Avoid higher taxes on short-term capital gains:
As you may already know, short-term capital gains are taxed at a higher rate than long term capital gains so, ideally, you want to hold on to your investments for at least a year. But, you can conduct short-term trades in your IRA, allowing any gains to grow tax deferred. Any distributions taken from that account in the future will be taxed at the same rate, avoiding the additional tax liability. It’s also best not to unload investments if doing so would mean a higher tax rate for the year.
3) Don’t pay tax on income you don’t need:
If you have multiple income streams while collecting Social Security, you receive a penalty in the form of higher taxes on the Social Security you’re paid. Once you begin collecting Social Security, be careful to only draw from your tax-deferred investments the money you need (and are willing to be taxed on) so the rest can continue to grow tax free.
4) Reduce taxes owed by utilizing ROTH conversions wisely:
ROTH conversions can significantly reduce the taxes you owe on money earned in your tax-deferred IRA. Since ROTH conversions are counted as taxable income, you should closely monitor your yearly income so that the money you convert doesn’t bump you up into the next tax bracket.
5) Beware the tax bomb on inherited IRAs:
If you inherit an IRA, you could lose up to 40 percent of that money as taxable income if you take the entire balance in a single distribution. Instead, you should elect to begin taking Required Minimum Distributions; they will be taxed at a lower rate because they are calculated on your age. That way, the remainder of the account can continue to grow tax deferred.
Clearly, a smart investment strategy is much more than watching your money grow. A comprehensive investment strategy is actually a moving target that needs to be monitored and adjusted on a regular basis. Any one of the strategies outlined above can be effective ways to minimize the amount of money you lose to the tax man. Unfortunately, the financial landscape is ever-changing and you should review your approach regularly in order to stay on track. Always seek the advice of a professional when considering investment strategies.
Register for our Q2 2017 State of the Company event on July 25th where we’ll discuss these strategies in further detail.