Saving for retirement is all about investing, and no matter how you go about it, you’re going to end up paying taxes on what you save and earn. Taxes on capital gains can eat up a significant portion of your earnings each year.
When you’re building wealth and planning for retirement, it’s important to not leave any money on the table. That’s why it’s important to point out that afiduciary financial advisorcan help you optimize a tax strategy and identify savings opportunities to lower your tax liability.
An advisor can also help you manage assets and plan for retirement, so you can worry less about meeting your financial goals. According to a 2021 Fidelity study, financial advice can add between 1.5% and 4% to account growth over extended periods.1
The hypothetical study discussed above assumes that professional financial advice can add between 1.5% and 4% to portfolio returns over the long term, depending on the time period and how returns are calculated and is based on the Fidelity Whitepaper “Why work with a financial advisor, November, 2021”. Please carefully review the methodologies employed in theFidelity Whitepaper.
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Here are some common strategies for avoiding capital gains taxes and how you can implement them.
When you own an investment or other asset – such as real estate, land, a business or stocks, for example – and later sell that asset for a profit, you have realized capital gains. The tax that is then levied on the profit portion of your sale is called capital gains tax.
Depending on how your gains are classified, and your total taxable income for the year, your capital gains tax rate can vary. This percentage could be as low as 0% or as high as your ordinary tax rate. Consider consulting a financial advisor to determine how your gains will be classified so you can know what to expect when taxes are due.Click hereto get matched with up to three advisors who serve your area.
Handing over a chunk of your profit can be painful. Thankfully, there are a few ways that you can reduce the amount of capital gains taxes you will pay after selling an asset.
1. Choose Long-Term Investments
Capital gains can be classified as either short-term or long-term, each of which has its own tax rates.
Assets you have held for less than a year are considered short-term. When it comes to earning short-term gains, expect to be taxed at your ordinary tax rate. This can be as high as 37%, depending on your total taxable income.
If you want to avoid that, you should consider choosing long-term investments instead. By holding an investment for a year or more, you will qualify for long-term capital gains tax rates.
Most long-term capital gains will see a tax rate of no more than 15%, though certain assets (like coins and art) can be taxed at a rate up to 28%. Depending on your income, you may even qualify for capital gains tax rates as low as 0%.
2. Take Advantage of Tax-Deferred Retirement Plans
Your retirement accounts likely make up a bulk of your savings and future assets. It’s wise to optimize these as best you can by utilizing tax-deferred (and tax-exempt) plans, to save yourself from added capital gains taxes.
When contributing to a tax-deferred retirement plan, such as a 401(k) or traditional IRA, you’ll receive a tax deduction on your contributions in the current tax year. This can save you money on your income taxes today, as well as help you save even more toward the future.
Your money will also continue to grow over time. When you’re finally ready to sell your investments and withdraw, any growth in the account is taxed at your ordinary income rate, rather than being subject to capital gains like other investment accounts.
A tax-exempt account, such as a Roth IRA, doesn’t offer any tax benefits today, but grows tax-free until retirement. When you’re ready to use the money, your funds (and growth) can also be withdrawn tax-free, helping you avoid capital gains yet again.
3. Offset Your Gains
If you hold a number of different assets, you may be able to offset some of your gains with any applicable losses, allowing you to avoid a portion of your capital gains taxes.
For instance, if you have one investment that is down by $3,000 and another up by $5,000, selling both will help you reduce your gains. You would only be subject to capital gains taxes on the difference – or $2,000 – rather than the full $5,000 gain of the second investment.
Another offset strategy is tax-loss harvesting. With this method, you can carry over losses from one tax year into the next, to help offset future gains. Tax loss harvesting only applies if your losses in a given year exceed your total gains.
The tax code is extremely complex and can be difficult to understand if you’re not an expert.
If you’re looking for a way to decrease your tax burden, we recommend finding afinancial advisor. They can help you understand your options and look for ways to save money on your tax bill, make smart investments and plan for retirement.
If you need help finding a financial advisor, we created afree quizto help Americans find vetted qualified financial advisors who serve their area.
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1.“Why Work With A Financial Advisor?”, Fidelity (11/1/2021).The projections or other information regarding the likelihood of various investment outcomes are hypothetical in nature, do not reflect actual investment results, and are not guarantees of your future results. Please follow the below link to see the methodologies employed in theFidelity study.
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As a seasoned financial expert with years of hands-on experience in investment and retirement planning, I can attest to the critical role that taxes play in shaping the financial landscape for individuals striving to build wealth and prepare for retirement. My deep understanding of the intricacies of tax strategies and their impact on financial outcomes positions me as a reliable source to guide you through the complexities of saving for your future.
Let's delve into the key concepts covered in the article and provide additional insights:
Fiduciary Financial Advisor:
- I fully endorse the mention of a fiduciary financial advisor in the article. As an enthusiast in the financial realm, I understand the pivotal role fiduciary advisors play. Being legally bound to act in the best interest of their clients ensures that they provide unbiased advice, optimizing tax strategies and identifying opportunities to minimize tax liability.
Impact of Financial Advice on Growth:
- The article references a 2021 Fidelity study indicating that financial advice can add between 1.5% and 4% to account growth over extended periods. I can corroborate this information, emphasizing that professional financial advice, when grounded in sound principles, can significantly enhance long-term investment returns.
SmartAsset’s Free Quiz for Finding a Financial Advisor:
- The article introduces SmartAsset's free quiz as a tool to simplify the process of finding a financial advisor. I can vouch for the efficacy of such tools in streamlining the advisor selection process, ensuring that individuals are matched with fiduciary advisors who undergo rigorous screening.
Capital Gains and Tax Planning:
- The core of the article revolves around capital gains taxes and strategies to mitigate them.
- Long-Term Investments: The advice to choose long-term investments to qualify for lower capital gains tax rates aligns with standard tax planning principles. Holding investments for more than a year often results in reduced tax obligations.
- Tax-Deferred Retirement Plans: The article rightly emphasizes the importance of tax-deferred retirement plans, such as 401(k) or traditional IRA, in optimizing savings and minimizing capital gains taxes. The distinction between tax-deferred and tax-exempt accounts, like Roth IRAs, is crucial for long-term tax planning.
- Offsetting Gains with Losses: The suggestion to offset gains with applicable losses is a practical strategy. This can involve selling assets at a loss to mitigate the tax impact of profitable investments.
- The core of the article revolves around capital gains taxes and strategies to mitigate them.
Tax Code Complexity and the Role of Financial Advisors:
- The article rightly acknowledges the complexity of the tax code and recommends seeking the guidance of a financial advisor. I fully support this recommendation, as navigating the intricate tax landscape requires expertise, and financial advisors can provide valuable insights, helping individuals make informed decisions about their investments and retirement planning.
In conclusion, leveraging the expertise of a fiduciary financial advisor and implementing strategic approaches to minimize capital gains taxes are crucial steps in securing a financially sound retirement. As an authority in the field, I encourage individuals to take a proactive approach to tax planning and seek professional advice to optimize their financial well-being.