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Tax efficiency can give you more money for your own financial goals.
This allows them to increase their income or gains, while reducing their overall tax bill.
Just like your regular income, the IRS can tax income earned from an investment portfolio.
The way it taxes investment income is different from your employment wages, however.
Not only is your investment income assessed differently, but you could be taxed at a different rate.
Making aninvestment portfolio taxefficient minimizes taxable events.
For example, an investor could open a tax-advantaged Individual Retirement Account (IRA).
If they havegains and dividendsreinvested, these earnings can continue to grow over time without being taxed.
Theyll only be subject to taxation upon withdrawal.
IRAs arent the only bang out of tax-efficient account.
Note that not all income-producing accounts are tax efficient, and some are taxed differently than others.
Certain accounts are tax-deferred, meaning the money grows tax-free until withdrawn.
Others like Roth IRAs require the investor to pay taxes upfront.
The tradeoff is any qualified withdrawals are tax-free.
Say youre in debate between opening a Roth IRA and a Traditional IRA.
Both are tax-advantaged, but in different ways.
When structuring or restructuring your investments, choose a mix of tax-advantaged and taxable accounts.
This will enable you to minimize your tax liability.
While theres no one right way to achieve tax efficiency, here are afew tried-and-true methods.
When you sell one of them, theyll be subject to either a capital gain or capital loss.
A realized capital gain happens when you sell an investment for more than its original purchase price.
A capital loss is when you sell an asset for less than its original value or purchase price.
In other words, holding your investments for the long-term could mean amore favorable tax rate.
Use Tax-Advantaged Accounts
Using tax-advantaged accounts is another way to achieve tax efficiency.
This can reduce your tax liability for the year.
It can also minimizeshort-term capital gains, which preserves your investment portfolio.
Say you sold an asset that incurred a capital gain.
This can potentially result insome major tax savings.
But what if your capital losses are higher than your capital gains?
Any amount higher than this limit gets carried over to future years.
Use a Health Savings Account (HSA)
Contributing to an HSAcan also help with tax efficiency.
Generally speaking, investors should take advantage of both tax-advantaged and taxable accounts.
That way, they can balance therisks and rewardsof investing, while keeping their overall tax liability low.
Each comes with its own tax benefits, as well aspotential drawbacks and limitations.
Potential Drawbacks and Considerations
Everything, including tax efficiency, comes with its potential drawbacks.
Its also important to understand the tax consequences of different types of accounts before adding any to your portfolio.
When in doubt, consult a tax professional or financial advisor about your options.
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