When you get to the point of selling off a few of your holdings or withdrawing from your retirement accounts, you might wonder what’s the best way to go about it. Are there tax benefits of doing it a certain way? Of course! For as long as there have been taxes, people have figured out ways to pay less of them – or how to be more tax efficient. To be tax efficient means to be taxed at a lower rate and achieve the same result as you would otherwise.
What are some ways to become more tax efficient?
You should try to limit your taxable events or, at least, minimize the high tax rate events while maximizing the low tax rate ones. Holding on to profitable stocks for more than a year is one of the easiest way to eliminate short-term capital gains.
To avoid being taxed and penalized after withdrawing from a retirement plan, employees should directly roll over old 401k plans to their new employer’s plan or to an IRA, since a direct rollover doesn’t create a taxable event.
Basic tax definitions
A taxable gain is the profit that results from the sale of any asset. To calculate the taxable gain, take the difference between the sale price of the investment and the original purchase price.
Tax-deferred means that earnings like interest, dividends, or capital gains will accumulate tax-free until you withdraw. The most common ones are IRAs and some annuities.
A taxable event is any transaction that results in a tax consequence for the person who makes the transaction. Some examples of taxable events for investors are receiving interest and dividends and selling securities with a profits.
So often in finance it’s not about what you make, but it’s more about what you keep – taxes are important to consider when choosing an investment strategy. Generally speaking, you want a solid mix of pre-tax and post-tax investments. The combination of a 401k plus an IRA is a great example. Because your dollars are being invested both before and after they’ve been taxed, your burden will be a little lighter when you withdraw the money for retirement.
The information provided herein may not be relied on as tax advice. Please seek tax advice from a tax adviser.