Taxes are an emotional issue. Sometimes, people's focus on
avoiding them can distract them from what is in their best
Here are five mistakes you should avoid when managing the taxes
on your investments.
1. Overlooking taxable retirement distributions
Qualified retirement plans have certain tax advantages. Money
going into a traditional IRA or a 401(k) can be deducted from your
income, and earnings on your investments within these plans is tax
exempt as well. There is a catch, though: The distributions you
ultimately take out of these plans is taxed as income at that
This has a couple implications. First, when you are doing your
retirement planning and
figuring out how much income you'll need
, be sure to account for the fact that money coming out of a
retirement plan will be taxed. Second, depending on your tax
bracket, there may be a disadvantage to having growth investments
in your IRA, since any gains will ultimately be taxed as income,
and not at the capital gains rate.
2. Trying too hard to avoid capital gains taxes
Speaking of capital gains, people are sometimes reluctant to
sell stocks when they are up because realizing the gain will make
it subject to taxation. However, it's important not to let the tail
wag the dog. Paying a 15 percent tax on a 50 percent gain will
actually cost you only 5 percent of the total value of the
investment. You could lose much more than 5 percent if the
investment goes south on you while you are putting off selling.
3. Harvesting capital losses carelessly
Some investors like to "harvest" losses near the end of the year
to offset gains. When you do this, keep in mind the potential
opportunity cost. Harvesting a 20 percent loss would have a tax
benefit equivalent to less than 4 percent of the investment's
current value, so you shouldn't sell if you think that stock might
bounce back by 4 percent or more during the 30-day waiting period
before you would be permitted to repurchase the stock.
4. Gambling on off-shore accounts
Cypress is an example of an off-shore haven that was popular
with people trying to shelter money from their own governments. But
when the banking system in Cypress was in crisis, many of those
foreign accounts were assessed huge levies to bail out the banks.
Those investors probably wish they had just paid their taxes in the
first place. Tax evasion is not only cheating, but if it involves
moving money out of the country, it also entails giving up the
protections of U.S. law and
5. Forgetting Treasury securities
Considering how some people go overboard to avoid taxes, the tax
benefit of owning U.S. Treasury securities is surprisingly
overlooked. Income on these securities is subject to federal taxes,
but exempt from state and local income taxes. This might be
especially relevant now because Treasury yields have been rising
while CD rates have not. So a five-year Treasury might be an
attractive income alternative to a five-year CD, with the added
benefit of a break on state and local taxes.
The bottom line is that tax considerations should not be blown
out of proportion. They should be quantified, and then judged in
connection with the risk and return potential of each financial
decision you make.