Step 2: Taxable Money

WITH A RETIREMENT account, your investments grow tax-deferred, so you don’t have to worry about tax bills until retirement. But with a taxable account, trading too much or buying investments that pay a lot of immediately taxable interest can mean a heap of pain at tax time.

To avoid that pain, consider four strategies, which are discussed in the sections that follow. First, focus on generating long-term capital gains by hanging onto your individual stocks or stock funds for more than a year—preferably much more. The maximum long-term federal capital gains rate in 2023 and 2024 is 20%, well below the 37% maximum income tax rate. What if you hold your winning stocks or stock funds for a year or less? It counts as a short-term capital gain—and the higher ordinary income tax rate applies.

Second, periodically sell losing investments. The resulting tax losses can be used to offset realized capital gains and up to $3,000 in ordinary income each year. When taking tax losses, watch out for the wash-sale rule.

Third, when buying stocks and stock funds in a taxable account, favor those that either don’t pay dividends or, if they do, pay qualified dividends. Those qualified dividends are taxed at the same rate as long-term capital gains.

Fourth, if you’re in a high tax bracket and your taste runs to conservative investments, you might buy tax-free municipal bonds rather than taxable bonds. Munis pay interest that is typically exempt from federal taxes and, if you own bonds from your own state, potentially state and local taxes as well. What if your tax bracket isn’t so high, but you want conservative investments in your taxable account? You might focus on Treasury bonds, which kick off interest that’s exempt from state taxes, or savings bonds, which grow tax-deferred.

What does all this mean for your overall portfolio? That’s where the crucial issue of asset location comes in—deciding which investments to hold in your retirement accounts and which in your taxable account.

Next: Capital Gains

Previous: Variable Annuities

Article: How to Lose Less

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