Tax Efficient Investing

By Ted Rollins , last updated August 28, 2011
Tax efficient investing can make a major difference in the profits that actually make it into your pocket. For both low volume and high frequency investors, the taxman can take a huge chunk out of your profits. No matter what you do, he'll be there asking for a cut; however, if you plan things right, the bite he takes can be quite small. In the following, you'll learn a few strategies for investing your money in a tax efficient manner.
The easiest way to invest in a tax smart way is to put your money into tax deferred accounts. These include many popular investment categories like 401(k)s, 403(b)s, and annuities. In nearly all of these examples, any contribution you make with an investment is tax deductible. In most cases, earnings on these investments compound in a tax deferred manner, which can really pay off when you want to withdraw your money. However, you sometimes need to wait for withdrawal (the standard age is 59 1/2) to avoid paying a large tax penalty.
Municipal and government bonds also offer a smart tax efficient investment. Income from municipal bonds is exempt from federal taxes, and in some states from local taxes as well. For government bonds, you don't have to pay state taxes either. While these usually don't offer lots of profit, they do reduce your tax burden substantially.
Another great option for tax efficient investing with more growth opportunity is in real estate investment trusts or REITs. These give you great exposure to the real estate market. For normal investors, REITs work like a normal stock in terms of taxes, but they have the benefit of only being taxed when they earn back most of their investment, making them less risky tax wise than comparable real estate investment options. Lastly, keeping great records of all of your tax-related transactions may be the best tip for tax efficiency, as it will save you countless hours during tax season!
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