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Taxable Versus Tax-Deferred Accounts
JOHN J.
CIAFONE, ESQ.
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BY JOHN SAVIGNANO, CPA
Some people do all of their investing
in an employer-sponsored
retirement plan where earnings are
untaxed until withdrawn, and perhaps
in an IRA as well. Withdrawals
are generally taxed at ordinary
income rates which now go up to
39.6%.
Conversely, others have taxable
accounts as well; each year, income
tax is due on investment interest,
dividends, and net capital gains in
these taxable accounts. Some dividends
and gains qualify for favorable
rates, currently no higher than
20%. (Taxpayers who are subject to
the 3.8% surtax on net investment
income might actually owe 23.8%).
Therefore, investors with a foot on
both sides of the tax-now-or-tax-later
line must make some decisions
about their savings and investments.
Which types of assets go into tax-deferred
territory and which assets
work better in taxable accounts?
Making informed decisions can help
you substantially in long-term results
from your investments after tax.
Financial advisers and investment
managers may have differing preferences
in this area.. Stocks inside
retirement accounts and bonds outside?
There are no universal rules
to follow and there are many factors
to consider when making decisions
about asset location. The “correct”
mix may vary from investor to investor.
Nevertheless, some basic principles
can help you in this decision.
Liquidity
Emergency funds should be held
in taxable accounts where you can
reach them if the money is needed.
That’s also the case if you’re saving
for a major outlay, such as a home
purchase or higher education. With
the money in a taxable account, you
can access the funds without owing
ordinary income tax or worrying
about 10% early withdrawal penalty
before age 59 ½.
Historically, liquid dollars were
often held in bank accounts and
money market funds. Yield on these
instruments are so low now that
investors may be using short-term
bond funds or something similar
to get some return on their money.
Even so, if you are holding assets for
use in emergencies or for an anticipated
expense, they probably should
be in a taxable account.
Availability
If you’re saving for retirement in a
401(k) or similar plan, you’ll be limited
to the menu options presented
to plan participants. Therefore, if
your investment plan calls for an
allocation to precious metals, you
may have to use a taxable account
for a fund that holds mining stocks,
say, or a gold bullion ETF. The same
could be true if you want to own an
emerging markets bond fund or a
small company growth fund, if no
acceptable option in these categories
is on your plan’s menu. Note,
that you can hold virtually anything
in an IRA (except for life insurance
and certain collectibles). Thus, your
IRA could be used for hard to find
assets.
If you have a plan regarding which
investments will help you attain your
goals, you can get an added return
when you know where to hold them.
John Savignano is a partner with
Savignano Accountants & Advisors
located at 47-46 Vernon Blvd.,
Second Floor, in Long Island City.
If you have any questions or require
additional information, please call
John at 718-707-0955.
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