Taxes. No one likes to pay them. Unfortunately, that old adage about death and taxes rings as true today as it ever has. Investment income is not spared either, but there are ways to decrease these taxes, or stop them from hindering the growth of your wealth through time.
1. Go long-term
The easiest way to cut down your annual taxes on investments is to hold them for more than a year. Short-term capital gains taxes are taxed as ordinary income. Long-term capital gains tax creates an incentive for long-term investors. To qualify for these lower rates, you must hold your investment for over a year.
The three rates for capital gains are 0%, 15%, and 20%. For a single filer, you can pay 0% on long-term capital gains if your income is less than $40,000. While most people pay 15%, filers that had income of over $441,500 actually pay 20% capital gains tax on long-term gains. Filing jointly creates a 0% tax for incomes of $80,000 and below. Above that, there is a 15% tax all the way to $496,600. Above that income, the 20% tax applies.
Whatever income bracket you fall under, you're still getting a tax advantage by holding investments for more than a year.
2. Take your losses
Sometimes, you make a bad play. It happens to the best of us. If you have a stock that has underperformed drastically, you can sell it and use that capital loss to offset your capital gains. By doing so, you can balance that against the profits you might take from an investment that has done tremendously well.
Obviously, this isn't exactly the most ideal scenario. But if you're sitting on a dud that you know isn't going to help you out in the future, selling that position to ensure you don't pay as much on your good investment is a strategy.
3. Use retirement accounts
Retirement accounts like IRAs and Roth IRAs offer the ability to invest with deferred taxes. On the IRA side, you can invest up to $6,000 (if you're over 50 you can contribute $7,000), and the gains are tax deferred until you begin to access them from the account. While you'll still end up paying capital gains in the end, the IRA is a means by which to grow your investments in a way that is unbridled by capital gains tax.
A Roth IRA does the same thing, except in reverse. You pay taxes on the money you put in, but the gains and eventual withdrawals are tax-free. You can also use a traditional 401k for tax-deferred investing.
Again, you're not really escaping capital gains taxes. What you are doing is creating a way to invest without the annual hit. This creates the ability to build more wealth over time.
Taxes are a part of life. Investors are rewarded for long-term plays through lower rates for long-term capital gains taxes. That, and prudent saving through retirement accounts, are the best ways to make the most of your money.
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