Keeping investment taxes low
Points to know
- Your account type, investment type, and trading behavior will all impact the amount you owe Uncle Sam.
Every investment decision is an opportunity to save
There are a lot of choices you'll need to make in investing, whether you're just getting started or you've been investing for decades. Many of these decisions will have a tax impact.
Taxes directly reduce your returns, so it's smart to familiarize yourself with the potential tax hits—or tax savings—you could be in for.
The profit you get from investing money. Over time, this profit is based mainly on the amount of risk associated with the investment. So, for example, less-risky investments like certificates of deposit (CDs) or savings accounts generally earn a low rate of return, and higher-risk investments like stocks generally earn a higher rate of return.
A type of IRA that allows you to make after-tax contributions (so you don't get an immediate tax deduction) and then withdraw money in retirement tax-free as long as you meet the requirements.
IRA (individual retirement account)
A type of account created by the IRS that offers tax benefits when you use it to save for retirement.
529 savings plan
A type of investment account that offers federal and state tax benefits to people saving for higher education. These plans are sponsored by particular states but are usually open to anyone. The money in a 529 savings plan can be used for tuition and other qualified expenses at thousands of colleges, universities, graduate schools, and trade and technical schools in the United States and abroad.
When choosing investments
Choose investments that are tax-efficient
Some investments, like index mutual funds and ETFs (exchange-traded funds), are naturally tax-efficient. Others, including tax-managed funds and tax-exempt bonds, were created specifically for investors concerned about lowering their taxes.
A type of investment that pools shareholder money and invests it in a variety of securities. Each investor owns shares of the fund and can buy or sell these shares at any time. Mutual funds are typically more diversified, low-cost, and convenient than investing in individual securities, and they're professionally managed.
ETF (exchange-traded fund)
A type of investment with characteristics of both mutual funds and individual stocks. ETFs are professionally managed and typically diversified, like mutual funds, but they can be bought and sold at any point during the trading day using straightforward or sophisticated strategies.
A note on after-tax returns
When reporting performance, mutual funds and ETFs include "after tax" figures that are meant to represent what an investor might have left over once taxes are paid.
These figures are unlikely to perfectly represent your exact situation, but they'll give you an idea of how tax-efficient the fund is.
Even if you're in a high tax bracket, it's important not to just focus on taxes when you're selecting funds. A fund with a return of 10% and a 3% tax bite is still going to leave you with more than a fund with a 5% return and a 1% tax burden.
After-tax return figures help you keep this total picture in mind.
When managing your portfolio
Manage different accounts in ways that minimize your taxes
If you own some accounts with tax advantages and some without, you have greater flexibility to lower your tax burden across all your accounts.
Consider selling at a loss
While you should never sell an investment for the sole reason of lowering your taxes, you should keep tax implications in mind when making trades.
Limit your trading
Every time you sell investments in a taxable account—especially if you're selling in order to lock in gains—you could be increasing your tax bill. Instead, stick to your investment plan and limit your trading activity.
Accounts that don't receive special tax treatment, so all interest, dividends, and capital gains are subject to taxation in the year they're received.
Tax savings without the hassle
When it comes to investing, the effects of taxes are just one consideration to keep in mind. If spending time and energy on investment decisions isn't your cup of tea, we can take on the responsibility for you.
Vanguard Personal Advisor Services uses strategies like the ones described above to help you meet your goals while minimizing the impact of taxes.
See how a Vanguard advisor can add value to your portfolio or call 800-523-9447 to speak with an investment professional.
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The services provided to clients who elect to receive ongoing advice will vary based upon the amount of assets in a portfolio. Please review the Form CRS and Vanguard Personal Advisor Services Brochure PDF for important details about the service, including its asset-based service levels and fee breakpoints.
All investing is subject to risk, including the possible loss of the money you invest.
The information contained herein does not constitute tax advice, and cannot be used by any person to avoid tax penalties that may be imposed under the Internal Revenue Code. Each person should consult an independent tax advisor about his/her individual situation before investing in any fund or ETF.
Advice services are provided by Vanguard Adviser, Inc., a registered investment advisor, or by Vanguard National Trust Company, a federally chartered, limited purpose trust company.