Should I Put My Investment In An IRA Or A Taxable Account?
Here are four tips to help you decide where to stash your investments.
1. Mind Your Tax Rate
In general there are two types of taxes you’ll experience: Ordinary income taxes, which you pay on income producing assets and assets held under one year, and long term capital gains, which is the tax you pay on the price appreciation of an investment that is held for longer than one year. Long term capital gains are taxed at a lower rate than ordinary income.
The max federal rate for ordinary income is 39.6% and the max for capital gains is 20%. Most professionals will likely be taxed at a 25-28% marginal tax rate and a 15% capital gains rate.
Based on that knowledge, the first thing you should consider is whether an asset is income producing. Bonds, mortgage REITs (real estate investment trusts), short term trades (holding a stock under 1 year), and non-qualified dividends, will be taxed at normal income rates.
For this reason it may make more sense to buy these types of assets in an IRA or Roth IRA. An IRA would allow you to wait to pay taxes until retirement, while a Roth IRA would allow you to have both tax free growth and distributions.
However, there are some other considerations you need to ponder before you simply place all of your income producing assets into your IRA.
2. Consider The Frequency of Trading
Say you’re an active trader. You consistently hold your investments for less than a year, so your investments will be subject to ordinary income taxes. It makes more sense to trade these investments in an IRA so you don’t pay taxes after every trade.
Active trading in a taxable account can seriously damage your returns.
Let’s say 25% you are in the 25% tax bracket, so you’ll sacrifice 25% of your gains to taxes every time you make a trade.
If you get to instead trade those investments in an IRA, your gains aren’t taxable until you withdraw them, so 100% of your gains are added to the capital in your account. This is the difference between growing your account at 10% before taxes and 7.5% after taxes.
After 20 years your investment would have grown 60% less than in the tax deferred account. As you can see, the impact of taxes will cause a MASSIVE difference.
If your account is more passive and few trades occur, then you may not have to worry about your tax rate as much.
3. Look At The Structure Of The Investment.
Some of the more popular investment companies people invest in are mutual funds, ETFs and master limited partnerships. Each is taxed by Uncle Sam in a different, making some better than others for an IRA account.
Today I’m just going to highlight one investment company that can cause you grief come tax time.....
To read the rest of the guide and watch the companion video, visit the blog post at: