Rim Country residents are more than knee-deep into tax season again. As you review all your forms, you might notice that your investment-related taxes seem rather high. While there may not be much you can do about it for the 2006 tax year, you can certainly take steps to become a more "tax-smart" investor in 2007.
To be specific, you may want to explore three types of investing: Tax-exempt, tax-deferred and tax-efficient.
One way to reduce your investment tax burden is to avoid paying any taxes at all. And you may be able to do that through two different types of investments: Municipal bonds and the Roth IRA.
Municipal bonds. If you are in one of the top tax brackets, you may find municipal bonds to be especially attractive. When you invest in municipal bonds, your interest payments are exempt from federal taxes, and possibly state and local taxes as well. (However, municipal bonds may be subject to the alternative minimum tax, and any increase in principal value may be taxable.)
Roth IRAs. If you've had a Roth IRA account for at least five years and you don't begin making withdrawals until you're 59.5, your distributions are exempt from federal tax. In 2006 and 2007, you can contribute up to $4,000 to your Roth IRA, or $5,000 if you are 50 or older. (Income limits will affect if and how much you can contribute.)
When you invest in a tax-deferred vehicle, your money will grow faster than it would if placed in an investment on which you paid taxes every year. Of course, you will eventually have to pay taxes on tax-deferred investments, but, depending on how you make withdrawals, you may be able to spread the tax burden out over a number of years.
You have several tax-deferred options available, including a traditional IRA, your 401(k) or other employer-sponsored retirement plans and fixed annuities. In 2006 and 2007, the contribution limits for a traditional IRA are the same as those for the Roth IRA. In 2006, you can contribute up to $15,000 to your 401(k), 403(b) or 457(b) plan, or $20,000 if you are 50 or older. In 2007, you can contribute up to $15,500 to your 401(k), 403(b) or 457(b) plan, or $20,500 if you are 50 or older.
Income taxes aren't the only types of taxes associated with investing. You will also have to deal with capital gains taxes. That's why it makes sense to be a "buy and hold" investor. If you hold your stocks for more than one year before selling them, then your gains will only be subject to a maximum capital gains rate of 15 percent. But if you sell your stocks within a year of buying them, then your gains will be taxed at your ordinary income tax rate. (The 15 percent capital gains rate is scheduled to expire at the end of 2008, unless Congress acts to extend, or make permanent, this rate. Otherwise, beginning in 2009, the long-term capital gains rate will revert to 20 percent.)
Long-term investors shouldn't consider taxes alone when investing. But, by considering tax-free, tax-deferred and tax-efficient options, you can go a long way toward brightening your investment tax outlook for 2006 and beyond.
Ross Hage is a licensed financial adviser with the firm of Edward Jones. For more information, call (928) 468-2281.