Keep more for yourself.
Our two cents
While it is wise to think of your portfolio as one entity, it can be helpful keep in mind that it should comprise two kinds of investments: tax-advantaged and currently taxable.
On the one hand, you may be planning for your future by contributing to a government-sanctioned, tax-advantaged retirement plan such as a traditional or Roth IRA.
In addition, you may be investing in a brokerage account, where the money is currently taxable. This is where you can put money beyond what you can contribute to your retirement accounts or the money that you have earmarked for shorter-term goals.
Take full advantage of tax-advantaged accounts.
Tax-advantaged accounts such as 401(k)s and IRAs are an investor's best friend. Here's why:
First, any earnings in these accounts can grow tax-free (although they may be subject to tax when withdrawn). The entire amount you invest in these accounts can compound free of taxation—potentially for decades. The chunk of money that would otherwise go to the government is instead working for you, compounding. Over time, this can make a huge difference.
Second, depending on the plan and on your circumstances, you may be able to deduct your contribution from your taxable income, leaving you with more money to invest. Qualified withdrawals from Roth IRAs are not taxed at all, because they are funded with after-tax dollars.1
Diversify your tax liability.
Choosing the best investments for your accounts.
Where you hold different types of investments—in a taxable or tax-advantaged account—can have a big impact on your taxes.
Some investments—such as equity index mutual funds, stocks held over one year, and municipal bonds—are by their very nature tax-efficient. It makes sense to keep these in your taxable accounts when you have a choice.
Other less tax-efficient investments—such as individual stocks that you buy and sell more frequently, actively managed mutual funds, and taxable bonds—could be good choices for your retirement accounts.You can use this chart to help you decide what type of account is best from a tax perspective:
Tax-smart ways to invest
- What to hold in taxable brokerage accounts
- What to hold in tax-deferred accounts
What to hold in taxable brokerage accountsIndividual stocks you plan to hold more than one year.>What to hold in tax-deferred accountsIndividual stocks you plan to hold one year or less.>
What to hold in taxable brokerage accountsTax-managed stock funds, index funds, low-turnover stock funds.>What to hold in tax-deferred accountsActively managed funds that generate significant short-term capital gains.>
What to hold in taxable brokerage accountsStocks or mutual funds with qualified dividends that are subject to lower tax rates.>What to hold in tax-deferred accountsTaxable bond funds, zero-coupon bonds, inflation-protected bonds, or high-yield bond funds.>
What to hold in taxable brokerage accountsMunicipal bonds, I Bonds (savings bonds).>What to hold in tax-deferred accountsReal Estate Investment Trusts (REITs).>
© 2017 Charles Schwab & Co., Inc. All rights reserved. Member SIPC. (0116-3593)
Understanding how capital gains are taxed.
A capital gain is the profit you receive when you sell an investment for more than you paid. You have to pay tax on this gain. There are two types of capital gains taxes:
- Long-term capital gains tax—Gains on stocks, bonds, and mutual funds held for over one year are currently taxed at a maximum federal long-term capital gains rate of 20%.
- Short-term capital gains tax—If you hold investments for one year or less, they are subject to federal income tax.
1. Tax-free withdrawals of earnings from a Roth IRA are permitted five years after you make your first contribution to the account and after you reach age 59½.