Follow "Tax Freedom Day" With Tax-Smart Investment Strategies
You won't find it on your calendar, but April 13 is Tax Freedom Day. And although it's not a national holiday, it can still be meaningful - if you use it as a starting point to review your own investment tax situation.
Tax Freedom Day is the date when average Americans will have earned enough money to pay their federal, state and local tax bills for 2009. Each year, the Tax Foundation, a nonprofit tax policy research organization, calculates when Tax Freedom Day will occur. The date changes from year to year, based on changes in tax laws and the rate of economic growth in the country.
Of course, the idea of a "day" in which you have put taxes behind you for the year is something of a fiction. After all, if you work for a company, your employer typically withholds taxes from all your paychecks; if you are self-employed, you probably pay taxes every quarter. And yet, it's useful to think of Tax Freedom Day because it can push you toward making some important changes - especially in the area of investment taxes.
If you think you may be paying too much in taxes on your investments, what can you do about it? Here are a few steps to consider:
Put more money into tax-deferred retirement accounts. If you have a 401(k), 403(b) or other employer-sponsored retirement plan, contribute as much as you can afford - and increase your contributions every time you get a raise. You generally fund your plan with pre-tax dollars, so the more you put in, the more you can lower your annual adjusted gross income. And your earnings grow on a tax-deferred basis, so you pay no taxes until you withdraw money from your plan. Although it's probably taken a hit over the past year and a half, your 401(k) or other employer-sponsored plan is still an excellent retirement savings vehicle.
Look for tax-free investment opportunities. If you are in one of the higher tax brackets, you might benefit from owning municipal bonds. When you own municipal bonds, or "munis,'' your interest payments will be free from federal income taxes; if the municipality that issues the bond is located in your state, your interest payments also may be exempt from state and local taxes. (Some municipal bonds may be subject to the alternative minimum tax, though, so contact your tax advisor before investing.) Your Roth IRA earnings are also tax-free, provided you don't take withdrawals until you are at least age 59-1/2 and you've had your account for five years.
Hold stocks for the long term. Income taxes aren't the only types of taxes associated with investing; you also may have to pay capital gains taxes. If you hold your stocks for more than one year before selling them, your gains will only be subject to a maximum capital gains rate of 15 percent. (This rate is effective through Dec. 31, 2010.) But if you sell your stocks within a year of buying them, your gains will be taxed at your ordinary income tax rate.
By following these suggestions, and by consulting with your tax advisor, you may be able to hasten the arrival of your personal Tax Freedom Day. And, at the same time, you might also speed your progress toward your long-term financial goals.