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Follow 'tax-smart' investment moves

6:10 PM, Mar. 27, 2013  |  Comments
Kacey DeWitt
Kacey DeWitt
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Now that tax season is here, and the debate over tax rates has been resolved (at least for now), you can focus on your tax return, which is due April 15. As you work on your return, you might see some areas in which you'd like to make some changes for 2013 and beyond - and one of these areas may be your investments. Specifically, can you find ways to become a more "tax-smart" investor?

You might be able to benefit from taking the following steps:

? "Max out" on your IRA. Depending on your income level, you might be able to deduct some or all of your contributions to a traditional IRA. And your earnings can grow on a tax-deferred basis.* (Roth IRA contributions are not deductible, but your earnings and eventual distributions will be tax-free, provided you meet certain conditions.) You can contribute to your IRA for 2012 right up until the April 15 tax-filing deadline. And for 2013, the annual IRA contribution limit has increased, from $5,000 to $5,500 (or $6,500, if you're age 50 or older).

? Boost your 401(k) contributions. You generally contribute pretax dollars to your 401(k), so the more you put in, the lower your taxable income. (Depending on your employer, you might even be able to make Roth contributions to your 401(k) plan.) So, every time your salary goes up, you might want to consider increasing your 401(k) contributions. For 2013, you can put in up to $17,500 to your 401(k) or other employer-sponsored plan, such as a 457(b) or 403(b). If you're 50 or older, you can add another $5,500 on top of the contribution limit.

? Consider tax-advantaged investments. If you can afford to put money away even after you've reached the limits on your IRA and your 401(k), you might want to consider other tax-advantaged investments. For example, you might be able to benefit from investing in municipal bonds, which provide interest payments that are free of federal taxes, and, in some cases, free of state and local taxes, too. (Some municipal bonds may be subject to the alternative minimum tax.) Another investment possibility is a fixed annuity, which offers tax-deferred earnings growth. Your financial and tax advisers can help you determine which, if any, tax-favored investments might be suitable for your individual needs.

? Avoid frequent buying and selling. Many people constantly buy and sell investments, hoping to boost their returns. Such frequent trading is usually ineffective, however - and it can also be "taxing." If you sell an investment that you've held for one year or less, you might have to pay the short-term capital gains rate, which is the same as your ordinary income tax rate. But when you sell an investment that you've held for more than one year, you'll be assessed the more favorable long-term capital gains rate, which will be 15 percent or 20 percent, depending on your income level. So, as you can see, you have a real incentive to be a "buy-and-hold" investor.

Generally speaking, taxes, by themselves, shouldn't drive your investment decisions. Instead, you should focus on an investment's suitability for your risk tolerance and long-term goals. Work with your financial adviser and tax professional to see how you might be able to make progress toward your objectives and still keep control of your investment-related taxes.

* Taxes are due upon withdrawal and withdrawals prior to age 591/2 may be subject to a 10 percent IRS penalty.

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