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Investing your money is a great way to build your savings to prepare for the future. Still, there are many factors to take into account when making investments, such as the specific tax considerations of each investment vehicle. Here are some potential ways to save on taxes when making your investment decisions.
Determine how long you’ll hold the investments: Tax codes usually encourage long-term investments. So, if you try to sell your investment within the first year of owning it, you’ll pay ordinary tax rates, which could be 25 percent to 35 percent or more on that asset. That’s why it’s important to hold individual stocks for more than one year. Securities held for more than a year may be taxed at a lower, long-term capital gains tax rate . Remember, you’ll have to pay taxes on dividends, but otherwise you only pay taxes on the value of the stock if and when it’s sold for a profit.
Consider where you keep your funds: Keeping your investments in the right place is vital to ensuring growth and reducing tax bills. Place your dividend-paying stocks into tax-advantaged accounts, such as an individual retirement account (IRA), Roth IRA, or 401(k). By regularly investing in your retirement account, you can reduce your taxable income and sustain tax-deferred growth. You’ll only pay tax on IRA and 401(k) accounts when you take the money out during retirement. For the Roth IRA, as long as you don’t withdraw the money until age 59½ and your contribution has been in the Roth IRA for five years, you don’t have to pay taxes when withdrawing the money you’ve invested. It may also be wise to consider placing funds with a high turnover ratio, or frequent trading, into your IRA or 401(k), since you can also defer paying those taxes until retirement.
If you choose to invest in a Roth IRA, keep in mind that contributions are taxed before the money is deposited in your account. On the positive side, your principal grows tax-free and you pay no further taxes upon withdrawal. This is especially advantageous if you think your taxes will rise in the future, since you're paying taxes now rather than later. Another advantage of the Roth IRA is that it has no required minimum distributions for the account owner, perhaps reducing your income tax liability during retirement.
Know how to handle losses: When investing, you have to accept the risk of taking a loss on one or more of your investments. If the loss can’t be recovered, many investors will sell investments and use the capital losses to offset capital gains and help reduce tax bills. If your net losses exceed your gains, you are only allowed to use a certain amount of capital losses to offset ordinary income each year.
Understanding the tax code for different investments will help you be strategic in your choices and help you reap the potential benefits. As always, consult with a tax advisor for guidance specific to your situation.
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This information is provided for educational and illustrative purposes only.
Wells Fargo Wealth Management provides products and services through Wells Fargo Bank, N.A., and its various affiliates and subsidiaries.
Wells Fargo & Company and its affiliates do not provide tax or legal advice. Please consult with your tax and legal advisors to determine how this information may impact your own situation.
Dividends are not guaranteed and are subject to change or elimination.
Traditional IRA distributions are taxed as ordinary income and may be subject to a 10% Federal Tax penalty if they are taken prior to age 59 1/2.
Qualified Roth IRA distributions are not subject to state and local taxation in most states. Qualified Roth IRA distributions are also federally tax-free provided a Roth account has been open for at least five years and the owner has reached 59½ or met other requirements. Withdrawals may be subject to a 10% Federal Tax penalty if they are taken prior to age 59½.