​Basic Investor Tax Tips You Need to Know to Maximize Your Portfolio

Henry Truc  |

With the markets off for Good Friday, investors may want to take this day off from trading to take care of some financial spring cleaning with the April 18 tax deadline right around the corner. Whether you’re a long-term investor or a pattern day trader, maximizing your tax savings is an important step toward building long-term profits.

To make sure you have all your bases covered, here’s a quick checklist of the tax considerations an investor should make when filing.

Maximizing Your Retirement Accounts

First and foremost, if you have a 401k account, especially one in which the employer matches your contributions, it’s in your best interest to maximize this tax-deferred benefit as much as you can. Basically, contributions made toward a 401k or IRA aren’t taxed until money is withdrawn from the account after you reach retirement age. Withdrawals will then be taxed as regular income at whatever bracket you fall into.

If your employer doesn’t offer a 401k, then hopefully you have an individual retirement account (IRA) to take advantage of the tax benefits. If you don’t have either, then…what exactly are you waiting for?

There is an abundance of options in the market today to choose from. Traditional mutual fund providers like Vanguard and Fidelity have been doing it for decades. Online brokerages like eTrade (ETFC) and TD Ameritrade (AMTD) allow more active investors to manage their own portfolios. If stocks aren’t your thing, you can look to marketplace lending platforms like LendingClub (LC) and Prosper for an alternative type of IRA platform. For those that want a set-and-forget approach, there are even newer fintech robo-advisors like Betterment and Wealthfront that automate the process.

There’s really no excuse if you have the cash to spare. Funding your 401k or IRA account helps to build your retirement nest egg and take advantage of tax deductions. For the 2016 tax year, the limits for 401k contributions is $18,000 (or $24,000 if you’re over the age of 50), and the limit for IRAs is $5,500 (or $6,500 if you’re over 50).

To Roth or Not to Roth

Depending on your tax bracket, choosing a traditional IRA or a Roth IRA could have major financial implications, both in the long term and short term. Unlike a traditional retirement account, which allows you to make pretax contributions, Roth retirement accounts take post-tax contributions so you won’t have to pay them later. The government’s myRA retirement program launched in 2014 is a form of a starter Roth IRA account.

But if you think your tax bracket at the age of retirement will be a lot higher than what it is now (looking at you, millennials), contributing to a Roth account right now over a traditional one makes a ton of sense. For those higher earners who don’t plan to work during their retirement years, or are expecting a significant reduction in income (think baby boomers), a traditional account is probably preferred.

The 2016 limits on Roth 401k and Roth IRA accounts are the same as traditional ones stated above.

Contributing to 529 Plan

Another tax benefit account to consider is a 529 College Savings Plan, which allows post-tax contributions to grow tax free to eventually be used on funding a beneficiary’s education costs at a qualified higher learning institution. Qualified education costs include tuition, administrative fees, room and board, books and computer equipment. While there aren’t necessarily any annual contribution limits, these state or institution-sponsored funds do have lifetime caps, usually in the range of $100,000 to $250,000. With education costs skyrocketing, it’s not a terrible idea for investors to sock away some funds here even if the benefits aren’t enjoyed immediately.

Mind Your RMDs (Required Minimum Distributions)

For traditional 401k and IRA account holders, the IRS requires you to start taking withdrawals from your retirement fund once you reach the age of 70.5 years old and start paying income taxes on those withdrawals. The minimum withdrawal is calculated based on the account balance divided by life expectancy years left according to the IRS.

Fortunately, Roth retirement accounts don’t have RMDs to deal with. So retirees forced to withdrawal from their traditional IRAs may want to consider directing those funds into a Roth IRA to continue to grow tax free.

Better Know Your Tax Rates

For active investors, the great thing about retirement accounts is that you can make trades without worrying about the tax implications of each transaction. For normal accounts, investors and traders need to be cognizant of how much their profits will be taxed for each specific trade. Positions held for less than a year receive no tax benefits, and will be taxed like normal income. Positions held for one year and beyond are considered as long-term capital gains, and enjoy a much lower tax rate. For 2016, the capital gains tax rate is 15% for most people. Those in the top income tax bracket also have to pay a higher capital gains tax rate of 20%.

Tax Loss Harvesting and Avoiding the Wash Sale

Now that all the retirement funding talk is out of the way, let’s get down to some other ways investors can lower their tax payments. For non-retirement accounts, the IRS allows investors to use realized losses in their investments to offset capital gains and income. This means that if you bought a security and had to sell at a loss, that loss can then be used to reduce the taxes you have to pay on your earnings. Each year, investors “harvest” these losses for tax purposes by selling their losers to offset their winners. You’re allowed to apply up to $3,000 in losses each year to lower your taxable income, but you’re also allowed to roll over additional losses to subsequent years. One important thing to remember is that once you sell an investment for tax loss harvesting purposes, there is a 30-day window in which you’re not allowed to buy it again. Otherwise, it’s considered a wash sale and you lose the tax benefit.

Feeling Charitable?

Another way to avoid paying taxes on capital gains is to just give it away. Investors looking to make generous donations to qualified charitable organizations may want to consider gifting winning stocks they plan to sell instead. This method allows investors to deduct the amount of the donation from their taxable income as well as avoid paying a capital gains tax on the investment they planned to sell.

Are You a Trader or an Investor?

This isn’t a philosophical question. Depending on how you’re categorized by the IRS, being a self-employed day trader can open the door to a whole bunch of tax write-offs that regular investors don’t get to enjoy. Like freelancers or entrepreneurs, any money spent on business expenses may be tax deductible. Expenses like your computer, trading software, commissions and fees, newsletter subscriptions, and other services could all be eligible as write-offs. Sounds like a sweet deal, right? Unfortunately, there’s no clear definition as to what determines someone is a trader or investor. There’s no minimum trade threshold or account minimum, necessarily, that would indicate whether or not you qualify. You just kind of have to do a lot of day trading. For some reason, the IRS decided to channel US Supreme Court Justice Potter Stewart on this one.

So if you haven’t filed your tax returns, hopefully some of these reminders will help you get a few extra bucks back from Uncle Sam this year. What other tax tips did we miss? Help your fellow investors out in the comment section below!



DISCLOSURE: The views and opinions expressed in this article are those of the authors, and do not represent the views of equities.com. Readers should not consider statements made by the author as formal recommendations and should consult their financial advisor before making any investment decisions. To read our full disclosure, please go to: http://www.equities.com/disclaimer.

Companies

Symbol Name Price Change % Volume
ETFC E*TRADE Financial Corporation 45.54 -0.27 -0.59 2,068,071 Trade
AMTD TD Ameritrade Holding Corporation 51.09 -0.03 -0.05 4,575,050 Trade
LC LendingClub Corporation 13.02 -0.01 -0.08 303,030 Trade

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