Ken Roberts: Tax treatment of investment accounts
June 7, 2018
Will Rogers once said, "The only difference between death and taxes is that death doesn't get worse every time Congress meets." Our tax code is highly complex and it is important to understand how it works so you can be as efficient as possible. Seek out professional tax advice from a qualified accountant if necessary.
Investment brokerage accounts are broken down into two basic types: taxable and qualified retirement accounts. The two primary types of qualified retirement accounts are traditional and Roth. With a traditional IRA contributions are tax deductible and the account can grow without taxation until distributions are made, then the distributions are subject to ordinary income tax. With a Roth IRA you contribute an after tax dollar, the account will grow without tax and when you're ready to retire the distributions are also free from income tax.
One thing that investors should do is maximize your qualified retirement account contributions for tax efficiency. The decision to use Roth or traditional depends on several factors including age and income.
Non-qualified brokerage accounts are taxed every year. Investments held less than a year are treated as short term gains or losses and investments held longer than one year are taxed as long term. Gains and losses can offset one another in the tax year that they are realized. Dividends are taxed in the year received but qualified dividends have a special lower tax rate.
Investments can be held long term for tax efficiency. Since taxes on a stock holding aren't due until the stock is sold it makes sense to hold some stocks for years and get long term capital appreciation without paying tax until the investment is liquidated.
Fixed income investors can use tax free municipal bonds in a taxable brokerage account if taxes are a concern. It doesn't make sense to use municipal bonds in a tax qualified retirement account. Municipal bonds are free from federal income tax and from state income tax if you reside in the state that the bonds are issued in. You can determine if tax free municipal bonds are suitable for you by calculating the TEY or taxable equivalent yield. The taxable equivalent yield is the result of dividing your coupon rate by your income tax rate.
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Taxes and investing can be fairly complicated and education is the key to understanding what's the best approach for your individual situation.
Kenneth Roberts is a Truckee-based Registered Investment Advisor. Information is at his blog at http://www.sellacalloption.com or 775-657-8065. The mention of securities should not be considered an offer to sell or solicitation to buy investments mentioned. Consult your investment professional to understand the risks and/or how the purchase or sale of these investments may be implemented to meet your investment goals. Past performance is no guarantee of future results.