Know the Rules

Some investments, such as fast-growing stocks, can generate substantial capital gains. These gains are recognized and generally taxable when you sell a security for more than you paid for it.

If you’ve owned that asset for over a year, you qualify for the long-term gains rate, generally 15 or 20 percent. The long-term gains rate also applies to qualified dividends. In contrast, short-term gains on investments held a year or less, are taxed at your ordinary-income tax rate–which is usually higher. Non-qualified dividends and interest income are also generally subject to your ordinary-income rate. The 3.8 percent net investment income tax (NIIT) might also apply depending on your income.

But if an investment is held in a tax-deferred account, like a traditional IRA, 401(k) or 403(b), it isn’t taxed until the money is taken out. It is then taxed at the tax rate you qualify for when you take it out, but the NIIT won’t apply to retirement plans.

When investing for retirement or other long-term goals, people usually prefer tax-advantaged accounts, such as IRAs, 401(k)s or 403(b)s. While some assets sit well in these accounts, others would do better in taxable ones. How can you tell the difference?

Choose Tax Efficiency

Generally, the more tax efficient an investment, the more benefit you’ll get from owning it in a taxable account, and investments that lack tax efficiency are best suited to tax-advantaged vehicles.

For instance, if you have an investment that is already tax-advantaged, like a municipal bond or passively managed index mutual fund, they are better in taxed accounts. This is because if you have tax-advantaged assets in a tax-advantaged account, you do not get double benefits. Holding these assets in an IRA or 401(k) would be a lost opportunity.

Take Advantage of Income

What investments work best for tax-advantaged accounts? Taxable investments that tend to produce much of their return in income. This category includes corporate bonds, especially high-yield bonds, as well as real estate investment trusts (REITs), which are non-qualified and therefore taxed at your ordinary-income rate.

Any other assets that utilize short-term gains are good opportunities for tax-advantaged accounts. Because short-term gains are taxed at a higher rate than long-term, putting those assets somewhere to shelter them from the brunt of taxation would be in your best interest.

Get Specific Advice

Making the most of your money is confusing at times. Different accounts and changing laws are a hassle to navigate alone. Come into Froehling Anderson and sit down with one of our financial professionals. We can sift through the jargon and help you plan your financial future. Contact us today to set up an appointment.