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Smart Moves to Pay Less Taxes on investments

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  BonnieB's Photo
Posted May 25 2010 04:03 PM

Sometimes, you have to put higher-taxed investments into taxable accounts. For example, if you’re saving for a short-term goal, stocks may be too risky, so you put your money in bonds or bond funds, or a savings account. Or you may be saving for a goal that doesn’t have a tax-advantaged account option. Don’t worry. Although you shouldn’t make investment decisions purely to avoid paying taxes, you can keep your investment taxes low with the following tactics:

Buy and hold individual stocks and bonds instead of stock or bond funds. You don’t pay capital gains on individual stocks and bonds until you sell them; fund managers may trade within stock or bond funds frequently, and you pay taxes on any gains from those trades. Sell individual securities in taxable accounts only to rebalance your asset allocation or because an investment hasn’t panned out as you hoped.

Buy municipal-bond funds or municipal bonds. If you want more bonds in a taxable account, purchase municipal bond funds. The federal government doesn’t tax municipal bond income. In addition, you don’t pay state taxes on municipal bond income if you buy municipal bonds issued by your state.

Delay selling until the capital gains are long-term. If you sell an investment before you own it for a year, you earn a short-term capital gain, which is taxed at ordinary income rates (for someone in the 25% tax bracket, that rate is 25%, versus the 15% for long-term capital gains). If you’re close to the one-year mark and the investment isn’t in mortal danger, hold off on the sale until you pass the one-year mark.

Wait until the next calendar year to sell. If the end of the year is close, delay a sale until January. That way, you don’t pay tax on the capital gain until the following year, which means you have a full year to use that money, for example, to earn interest on savings or invest in something else.

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Learn more about this topic from Personal Investing: The Missing Manual.

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