Taxes Reduce Your Investable Income
Many investors put their funds in non-registered accounts in order to avoid the high tax rates associated with dividend and interest income. This includes mutual funds, stocks, options, Exchange Traded Funds (ETFs) and bonds, as well as GICs. They pay lower tax rates. However, they may also cause several other tax issues for the investor.
Mutual funds are usually a good investment product because they offer diversification and lower cost than investing in the individual stocks and bonds themselves. However, when you sell mutual funds, not all of your capital gain is taxed at the lower tax rate. In fact, only 60% of the capital gain is taxed at your marginal income tax rate, or the rate you would pay if you reported all of your income. The other 40% is reported as a taxable capital gain in your income taxes and is subject to a much higher tax rate than the first 60%. Although this is only an approximate figure, it is a good rule of thumb to help you understand the tax implications of investing in mutual funds.
Taxes Reduce Your Real Returns
When you make a deposit to your investment account, you get an immediate reduction in your taxes. Within a traditional IRA or 401K, you’ll be able to deduct your deposit from your income taxes, and you don’t have to pay it back through taxes until you withdraw money from the account. This makes investing through a traditional IRA or 401K a tax-advantaged way of growing your retirement nest egg.
But it’s important to remember that although the money you deposit into an IRA or 401K reduces your taxes, it doesn’t go toward increasing your net worth. In fact, it actually lowers your net worth. In other words, the taxes you’re saving for retirement are more than offset by the taxes you’ll have to pay when you retire and start pulling money out of your retirement accounts.
What about Tax-Efficient Investments?
Most people realize they need to pay taxes on a variety of different investments, including the interest you earn on savings accounts. Because tax shelters can