Benjamin Franklin said, “Nothing can be said to be certain, except death and taxes.” The famous axiom by one of the Founding Fathers is true. Isn’t it?
This simply means being an investor you need to know what the government takes!
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Your government levy taxes not only the investment income – interest, dividends, rent on real estate, etc. – but also the capital gains.
Well, here we can say that the taxmen are smart too!
Being an investor you can’t just escape by making a direct investment in mutual funds, ETFs, limited partnerships, or REITs. For tax purpose, such entities possess transparency.
Now, we already know that tax efficiency is an essential element in maximizing and growing returns from investments. Unfortunately, the complications of both the tax laws and investing prevent a lot of investors from understanding how they can manage their investment portfolios to reduce the tax burden.
Bluntly put, here tax efficiency has a big role to play.
But what is tax efficiency?
Well, it is a measure of how much profit from an investment is left after the payment of tax.
Talking of tax efficiency, let’s explore some of the investment options that save on your tax bills:
Mutual funds are one of the most popular investment options across the globe. Despite the probability of creating a significant tax burden, in some cases, these funds are famous among investors for many other reasons.
As investors can’t control the investment activity of mutual funds, it becomes essential to ensure their mutual fund saves on their tax bill. There are various factors dictating the tax efficiency of your fund, including the trading activity’s frequency, the type of distributions, and the longevity of every investment in your portfolio.
Based on how long your mutual fund has held the assets, the returns on your funds may be taxed as capital gains or ordinary income.
Here, you must be confused, right?
To burst the bubble, not all the distributions from capital gains are taxed at the rate of capital gains.
However, one of the most useful ways to save taxes on mutual funds is to minimize its turnover ratio. Mutual funds are not just popular in the US but it has gain popularity among most of the Asian countries including India.
Exchange-traded Funds (ETFs)
Well, ETFs are considered somewhat tax efficient as compared to mutual funds.
Why? Well, there are two keys reasons behind it:
One, most of these funds are passively managed, this in itself makes fewer transactions as the investment portfolio changes only when there are changes to the primary index replicated by it.
Second, there is a unique mechanism of selling and buying of the ETFs. These funds use creation units that enable the sale and purchase of the assets in the fund altogether.
The City, State or Country issues the Municipal Bonds to finance spending. Commonly called “muni” are considered to be a safer investment option as they are backed by the government. However, these bonds offer lower returns.
Muni is sometimes referred to as triple tax-free bonds. Why?
Well, municipal bonds are exempt from city, state and federal taxes based on the area you live in. Nevertheless, no municipal bond is tax-free.
Health Savings Account
Next in the list is Health Savings Account (HSA). This account enables you to avail tax deduction for your medical expenses with tax-efficient investing benefit. Any amount that is put in a health savings account is tax exempt that lowers your tax bills at the year-end.
Any interest that is earned on your funds is tax-deferred, and the withdrawals aren’t tax-exempt as long as your money is spent the approved medical expenses.
Moreover, you can earn interest on this account until you use it for any medical expense. Not only this, these funds are totally under your control.
It also comes with a facility of HAS Investment when your HSA reaches a certain sum (generally USD 2000 or more).
What does REIT stand for? Well, being an investor you know it means – Real Estate Investment Trusts.
These investment options offer a tax-efficient exposure to the real estate business. At trust levels, these investments are tax exempt if they pay a minimum of 90% of the profits earned to the shareholders. However, investors should make payment of ordinary income tax on the dividends and the shares sold and bought.
U.S. Series | Savings Bonds
Well, to be frank, you usually overlook the U.S. Series | Savings Bond. Isn’t it?
Of course, you would because of its not-so-advantageous feature in comparison to other investment options. However, exempt from local and state taxes, you’ll be accountable for federal taxes on the interest income.
Wait, there’s more to add:
Using these bonds, based on your salary or income limits and other constraints, tax-free educational expenses may be paid by any qualified dependent or maybe you.
Now that you’ve read about the investment options that save on your tax bills, you can pick some advice on investing, yeah?
If you wish to carry a tax-efficient investment, you just don’t have to be active; you need to be proactive too.
Final Verdict – Taxes Matter!
Don’t give that look! Of course, tax matters!
The net returns to the investors are significantly impacted by taxes. You must go through all the nitty-gritty of taxes before you proceed with your investment. Being tax-aware makes a big difference in the amount of hard-earned money you keep versus the sum you pay in taxes.
Hey wait, this is not misleading you! This applies as long as it’s legal :P