One of the biggest reasons investors earn lower than expected returns is from taxes. Taxes eat up on any gains you earn, causing you to earn less than what a mutual fund or exchange traded fund earned in a given year. While this is annoying, the good news is that there are things you can do to lower your taxable income.
Understand that the goal of this post is to lower the taxable income you pay on your investments. I won’t be diving into the myriad of ways for you to lower your overall taxable income from your career, though I will touch on one aspect of it.
In the end, you should be able to keep much of the gains you earn away from the taxman and in your pocket instead.
3 Easy Investing Tips To Lower Your Taxable Income
#1. Invest In Your 401k Plan
If you have a 401k available at your job, you need to put money into this account. When you contribute to a 401k plan, that money is invested pre-tax. This means the government doesn’t tax it. Therefore, it is the simplest way to lower your taxable income.
If you can contribute $15,000 or more, you could easily drop yourself into a lower tax bracket and save yourself a serious amount of money on taxes. And even if you can’t drop to a lower tax bracket, you will still save money by contributing money into this type of account.
#2. Put Taxable Bonds In Tax Deferred Accounts
The next step to saving money on taxable income is to make sure you are investing in a tax efficient way. This means taking assets that produce ordinary income, like bonds and real estate investment trusts, and owning them in retirement accounts.
These assets are taxed the same as the income you earn from your job, whereas dividends and capital gains are taxed at a lower rate. Because of this, you should try to put as much of your bond and REIT holdings into retirement accounts since they are tax deferred accounts.
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#3. Take Advantage Of Tax Loss Harvesting
Another area where you can lower your taxable income is with tax loss harvesting. This means that once a year, you should look over your portfolio and take advantage of any losses.
The tax code allows you to offset short-term gains with short-term losses, and long-term gains against long-term losses.
Once you do this, then you can use either type of loss for either type of gain. And finally, if you have more losses than gains, you can write off up to $3,000 worth of losses annually against your ordinary income.
#4. Be Smart About Rebalancing
While rebalancing does help to increase your gains over time, it isn’t the easiest to do when taking into account taxable income. As a result, there is an easy solution to rebalance and be tax conscious at the same time.
To rebalance in a smart way, direct future money to the assets that need additional capital. Here is how this would work.
Let’s say you have a 60% stock and 40% bond allocation. You notice that it is currently a 70% stock, 30% bond allocation. Instead of selling 10% worth of your stocks and realizing a potential gain, you could simply put any money you were planning to invest into the bonds. You would continue to do this until your allocation got back to the 60% stock and 40% bond allocation you want.
At the end of the day, being aware of taxable income when it pertains to your investments is a big deal. Taxes eat away at your returns and income and as a result, leaving you with less money.
Take a little bit of time to be more tax conscious and work to keep the taxable income your investments produce as low as possible.