It Adds Up: Why Taxes Matter to Investors

Whether you’re a beginning investor or a savvy, experienced trader, it can be easy to focus so much on the returns of individual securities that you forget about taxes. In fact, the impact of taxes can turn eye-popping returns into mediocre ones.

“You certainly can’t avoid taxes, but you can develop strategies that may minimize their impact on your investment returns,” said Joe Correnti, senior vice president of brokerage product for Scottrade. “The starting point is to understand what types of taxes you might face, and how they affect your financial plan.”

We can’t give you specific tax advice because every situation is different. So if you have further questions, should consult with a tax advisor. But here are a few examples of key investing-related tax issues for your consideration.

Short-Term vs. Long-Term Capital Gains

Selling a security for a profit after holding it for one year or less can result in paying a larger federal tax than if you held it for longer than a year. A short-term gain (one year or less) is usually taxed at the same rate as your income. So the higher your income, the higher the tax rate on short-term gains. Long-term gains are capped today at 20% for the highest bracket (39.6% and above), while lower-income investors (those in 10% to 15% income tax brackets) pay no capital gains (and the rest pay 15%).

Retirement Accounts

Investing through a retirement account could help reduce taxes – typically either an IRA or an employer-sponsored 401(k). Many employers typically offer traditional and Roth versions. There are lots of rules about how much you can contribute and certain income limits apply. But from a tax perspective, here are some things you need to know:

  • With a traditional 401(k) or IRA, you contribute pre-tax funds. However, you will likely have to pay income taxes when you withdraw the money; earnings usually grow tax-deferred. In general, contributing to a traditional 401(k) or IRA could make the most sense if you think you will be in a lower income-tax bracket when you retire.
  • With a Roth 401(k) or IRA, you contribute after-tax funds. However, earnings typically grow tax-free. In general, contributing to a Roth 401(k) or IRA could make the most sense if you think you will be in a higher tax bracket when you retire.

Education Accounts

Saving for education? Scottrade offers Coverdell accounts. Contributions are not deductible, but earnings grow tax-free. Distributions are tax-free if they’re used for qualified education expenses. In addition, you can invest in a 529 plan for tax-free growth of contributions.

Health Savings Accounts

Health savings accounts, which are available to individuals enrolled in a high-deductible health plan, offer a unique blend of 3 potential tax advantages. Contributions are tax-free, earnings grow tax-free and funds usually can be withdrawn tax-free if they’re used for qualified medical expenses.

State Taxes

You should be aware of how capital gains are treated in your state, along with other potential tax advantages that might be offered. For example, some states offer significant tax advantages in 529 plans.

“Taxes do matter,” Correnti said. “And with a little bit of knowledge, you can work to help maximize your investment returns.”

Next Steps: You can review tax-advantaged and other accounts offered at Scottrade.

The content provided is for informational and/or educational purposes only. The information presented or discussed is not, and should not be considered, a recommendation or an offer of, or solicitation of an offer by, Scottrade or its affiliates to buy, sell or hold any security or other financial product, or an endorsement or affirmation of any specific investment strategy. You are fully responsible for your investment decisions. Your choice to engage in a particular investment or investment strategy should be based solely on your own research and evaluation of the risks involved, your financial circumstances, and your investment objectives. Scottrade, Inc. and its affiliates are not offering or providing, and will not offer or provide, any advice, opinion or recommendation of the suitability, value or profitability of any particular investment or investment strategy.

Scottrade does not provide tax advice and the information contained herein is not meant as a replacement for professional advice. Please consult your tax or legal advisor for questions concerning your personal tax or financial situation. 

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