Tax efficient investing involves strategies to help reduce the impact of taxes. Investments have three tax flavors: taxable, tax-deferred and tax-exempt. Taxable requires gains to be paid as they are earned each year. These include investments like CDs and money market funds. Tax-deferred gains remain sheltered from taxes until withdrawn for retirement at age 59 ½ like 401(k)s or IRAs. Tax-exempt interest is not taxable either by federal or state taxes.
To determine the tax effect of your investments, you must know which tax bracket you’re in and if capital gains rules apply. The highest investment income minus the lowest taxes due is your investment goal. So, focus on placing fully taxable investments in tax-deferred accounts.
Don’t make the common mistake of putting investments that have tax benefits into an IRA. You will lose those tax benefits since all distributions from traditional IRAs are 100% taxable.
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