Average investors need all the tax breaks they can get, especially when they invest for retirement. All investments are not taxed the same. Consider this your basic investment guide to understanding the tax breaks available to most investors.
Ordinary taxation offers investors no tax breaks. For example, you hold a CD jointly with your spouse or in your name only, and earned $4000 in interest last year. At tax time this is considered interest income, and is taxed at your normal tax rate. If you are in the 25% tax bracket, you will pay $1000 in income tax on the $4000. We have many more Investing Help Articles Now Available.
Long-term capital gains is a tax treatment or tax break for investors who hold an investment long enough to qualify, and sell it for a profit. For example, you hold a stock for a couple of years, then sell it for a profit. Instead of your profit being taxed at your normal rate of 25%, it is taxed at a lower rate, like 15%. Note that this is only a basic investment guide, an example to illustrate a concept. Tax law here is notorious for changing.
Tax deferral is a popular tax break for folks who invest for retirement. The traditional IRA and 401k offer this advantage, as do tax-deferred annuities. For example, in a traditional 401k plan your money grows uninterrupted by income taxes. When you retire and pull money out of your plan the amount pulled out is then subject to income taxes at your ordinary rate. In your working years you avoided paying income taxes on earnings and interest, when you were likely in a higher tax bracket. In retirement you will likely be in a lower tax bracket when you pull money out and pay taxes on it.
Tax-qualified retirement plans like the 401k and IRA offer many folks tax deductions as well as tax deferral. For example, you invest $4000 in a traditional IRA. If you qualify, at tax time you deduct $4000 from your income as an adjustment. If you are in the 25% tax bracket, you just saved $1000 in income taxes.
Tax-free or tax-exempt investments or accounts should not be overlooked. Folks in higher tax brackets benefit from tax-exempt income from municipal bonds and mutual funds that invest in them. If you invest for retirement in a Roth IRA or 401k, you invest income-tax free. Your money grows free from income tax. The money you pull out in retirement is free from income tax as well, as long as you follow the rules. As a basic investment guide, tax-free investing is about as good as it gets for most of us. If you want to invest for retirement, consider Roth plans. We have many more Investing Help Articles Now Available.