Using the right investment account
Maximize your return on investment
If you realize a profit from the sale of a stock held in a regular taxable investment account you will have to pay capital gains taxes on the gain (in addition to income tax on any dividend payments you receive). The amount of taxes you will have to pay will vary according to how long you held the stock and your current income tax bracket. If the investment is held for less than one year, you will have to pay short-term capital gains which are taxed at the same rate as your ordinary income tax bracket. These taxes reduce your net profit and if you are an active trader can have a significant impact on your net returns. To reduce the amount of taxes you pay now you can utilize use tax-sheltered accounts. Before you make any major financial decision or when reviewing your financial plan you will want to consider the tax implications.
Tax-sheltered accounts such as traditional IRAs, Roth IRAs and 401(k)s provide a substantial advantage to investors as they allow your investments to grow tax-deferred or tax-free until retirement. The more investment capital you can shelter from taxes now the more you can continue to invest for growth. Since these accounts provide significant advantages Congress has limited the amount you can contribute each year. In most cases you will want to ensure you are using these tax sheltered accounts to their full potential.
First of all, you should try to contribute the maximum allowed yearly limit. Any money above this limit that you would like to invest must be placed in taxable accounts. In order to use the tax sheltered accounts to their full potential you will want to place the more tax-inefficient investments, those where you would be required to pay high current taxes, in your tax-advantaged account, while the tax-efficient investments should be placed your regular taxable account.
Regular Bonds are investments that you will want to keep in your tax-sheltered account. This is because they pay out interest that is taxed at your ordinary income rate which is very tax inefficient. Bond funds and TIPS should be held in your tax-sheltered account for the same reason. If you are an active stock trader, in order to avoid the high shortterms capital gains, these stocks should be held in your tax-efficient accounts. High-dividend paying stocks are also not very tax friendly. Actively managed stock funds that do a lot of short-term trading (check the turnover ratio of the mutual fund) are very tax-inefficient and thus should be kept in your tax-sheltered account. REITs are also another example of a very tax-inefficient investment that is best kept in a tax-sheltered account.
Municipal-bonds should be kept in your taxable accounts because they generate tax-free income. Stocks that you will hold for more than one year are very tax efficient so you can keep them in your regular investment account. Passively managed stock index funds also tend to be taxefficient along with ETFs.