Unless you're an absolute last-minute procrastinator --
or you've filed for an extension
-- then it's time to put tax season behind you. But even as you bid
farewell to the 2010 tax year by sending off your 1040 to the IRS,
now is a great time to start thinking about what you can do to make
next
year a much better one by cutting your tax bill.
For many people, taxes are something you think about twice a
year: once in late December as you scurry to get last-minute
deductions in under the wire, and once more in the first two weeks
of April as you're getting your annual filings in order. If you
make
tax planning
just as important as the rest of your financial plan, then you'll
put yourself in a much better position to save money on your taxes
in the future.
Let's look at some simple techniques you can do now to get your
tax bill under control for 2011 and beyond.
Gimme shelter
For many, tax shelters have an ominous ring, suggesting
questionable strategies designed more to evade taxes than for any
legitimate purpose. But there's one way to cut your taxable income
that's completely on the up-and-up:
contribute to your 401(k) plan
at work.
The nice thing about a 401(k) plan is that if your employer
offers one, you can participate without any questions about income
limitations or other restrictions. And by contributing part of your
paycheck to a 401(k), that income essentially disappears from your
tax return -- it's excluded on the W-2 that gets sent to the
IRS.
So if you haven't already done so, consider starting or upping
your contribution to your 401(k) at work. It's one of the best tax
shelters around.
Be tax smarter
Even with tax-favored accounts like 401(k)s, you'll inevitably have
to pay
some
tax on your investments. But you have a lot of control over
how much
you have to pay.
One way to cut your taxes is to put high-tax investments in
tax-favored accounts while using your regular accounts to hold
lower-tax investments. For instance:
-
Top-yielding dividend investments
American Capital Agency
(Nasdaq: AGNC) ,
Annaly Capital
(
NLY
) , and
Chimera Investment
(
CIM
) have attracted many investors because of their big payouts in
the current favorable interest rate environment. But their
dividends don't qualify for the low 15% maximum tax rate, making
them much better suited to being in IRAs.
- On the other hand, many of the most popular, high-paying
traditional dividend stocks
do
qualify for that lower rate, including
Altria
(NYSE: MO) ,
Philip Morris International
(NYSE: PM) , and
Frontier Communications
(
FTR
) . So with
their
high yields, you may actually
save
taxes in the long run by paying the lower 15% rate in a regular
account rather than eventually paying a potentially higher rate
when you take IRA withdrawals in retirement.
- Some investments are tax nightmares if you hold them in the
wrong place. The natural gas ETF
United States Natural Gas
(NYSE: UNG) , for instance, issues its income on a K-1
partnership return, which adds orders of magnitude to the
complexity of your tax return if you have it in a taxable
account. If you decide for some reason that you have to own this
or similar ETFs despite their structural flaws, then stick it in
an IRA.
Don't wait to look for losses
Tax-loss harvesting is something that most investors wait until
late in the year to do. But if you have a losing stock that you
don't think is going to recover, there's no reason not to get that
money working harder for you elsewhere.
Often, stocks go nowhere because the overall market is in the
doldrums. The last thing you want, though, is to own a stock that
doesn't rise when the rest of the market goes up. Yet that's
exactly what happened to many investors last fall, when the broader
market shot up throughout the remainder of the year.
Sometimes, it's just time to move on. By cutting bait early, you
can sometimes get yourself into a better stock in time to enjoy
much better returns than you'd earn hoping for a turnaround from a
losing stock.
It's your money
Taxes shouldn't be the only consideration in your investing, but
you shouldn't ignore them either. By keeping taxes on your mind
throughout the year, you'll identify more opportunities to cut your
tax bill and keep more of your hard-earned money for yourself.
Learn all the basics of financial planning with our 13 Steps
to Investing Foolishly. It'll get you on track to a great
financial plan in no time.
Tune in every Monday and Wednesday for Dan's columns on
retirement, investing, and personal finance.
Fool contributor
Dan Caplinger
likes to find ways to keep money. He owns shares of Chimera
Investment. Philip Morris International is a
Motley Fool Global Gains
selection. The Fool owns shares of Altria Group, Annaly Capital
Management, and Philip Morris International. Try any of our Foolish
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. We Fools may not all hold the same opinions, but we all
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