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Tax-efficient Investing

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A lot of time, people don’t start thinking about their taxes until a just few months before the filing deadline.

But to minimize the effect of taxes on your portfolio, tax-efficient investing should be a year-round endeavor, and there’s no better time to start than right now.

First, consider the advantages of putting some of your money in a tax-deferred account—like an IRA or a 401K. 

These accounts offer you the chance to reduce your taxable income and provide tax-free growth until retirement. 

Many employers also match your contributions to these accounts, so, at a minimum make sure you contribute enough to get that additional money. 

Next, when it comes to location, it doesn’t just matter for real estate; it also matters for your investments. 

By strategically placing your investments in the right location, you can help to minimize how much tax you’ll end up paying.  

For example, investments in your brokerage account generate taxable income—but when you hold them for over a year, you end up paying the lower capital gains tax rate. 

It also makes sense to keep tax-free investments, like municipal bonds, in that account.

On the other hand, tax-deferred accounts are taxed at the higher ordinary tax rates, but not until the money is withdrawn. 

So it makes sense to keep investments that generate ordinary income in those accounts, like bonds that pay interest or stocks that you trade regularly and hold for less than a year.

These investments tend to lose more of their return to taxes, so hold them in a tax-deferred account where you could benefit from compound growth.

Also, consider the benefits of tax loss harvesting.

Even in a bull market some of your investments might under-perform.  Don’t be afraid to close out some of those losing positions and replace them with other investments. 

You can use those losses to offset some of your capital gains and if there’s anything leftover, you can use it to offset up to $3000 of your ordinary income.

For more tips on managing your taxes efficiently, watch the other videos in this series, or visit our Tax Strategies page on Insights & Ideas.

Important Disclosures

The information provided here is for general informational purposes only. It is not intended to be a substitute for specific individualized tax, legal or investment planning advice. Where specific advice is necessary or appropriate, Schwab recommends consultation with a qualified tax advisor, CPA, financial planner or investment manager.

The Schwab Center for Financial Research is a division of Charles Schwab & Co., Inc.

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