Maximize Your Retirement: Tax Tips for Investment Profits

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This week on the Finance Friday installment ,  a great question from Elaine.

“I’m retired and have Social Security benefits, a pension, savings, and a traditional IRA. About six years ago, I bought some real estate stock that went up, and I’m thinking about cashing it out. What taxes would I owe on the sale, and how should I reinvest the money?”

Thanks so much, Elaine! I’ll review what tax you must pay on various investments and recommend some options to consider when you have extra cash in retirement.

Types of investment taxes

Anytime you’re fortunate enough to make money, whether from an employer, your own business, or an investment, you typically owe taxes. For 2024, your ordinary income is taxable according to seven brackets ranging from 10% to 37%. 

Examples of “ordinary” income include:

  • Wages
  • Salaries
  • Tips
  • Bonuses
  • Commissions
  • Rents
  • Royalties
  • Short-term capital gains
  • Unqualified dividends
  • Interest income

However, certain types of investment income, including long-term capital gains and qualified dividends, are taxed differently. Some taxes are due only if you choose to sell an investment for a profit, and others are due when you get paid a distribution. 

Another consideration is the type of account where you own an investment. For instance, with a tax-advantaged account, like a traditional 401(k), you only owe taxes once you take retirement withdrawals. Or, with a Roth IRA, you get tax-free withdrawals in retirement if you own the account for at least five years.

But for capital assets, like a home, or investments in a taxable account, like a brokerage, taxes are due when you earn money from them. The tax rate you must pay depends on factors I’ll cover in a moment.

What are capital gains?

The first type of investment income, capital gains, arises when you choose to sell an asset, like a stock or home, or more than you paid for it. Your profit minus your cost basis is called a capital gain. For instance, if you buy one share of stock for $20 and sell it for $30, you have a $10 capital gain. 

Remember that a capital gain is only taxable if you “realize” it by selling the asset. If you have an unrealized gain, also called a paper gain, it’s not taxable. You can watch your asset appreciate and won’t have to pay capital gains tax until you sell it.

Let’s say you have a $10 gain. You’d owe capital gains tax on the entire amount. If you owned the share for a year before selling it, you’d have a long-term gain, which is taxed at reduced rates, currently ranging from 0% to 23.8%, depending on your total taxable income and tax filing status.

Note that some investments have higher capital gains tax rates. For instance, collectibles, like rare coins and art, typically have a long-term capital gains tax rate of 28%.

Elaine mentioned owning her stock for six years, so she would owe long-term capital gains on the sale–unless she owns the stock inside a retirement account. But we’ll assume she owns it in a taxable brokerage. Her tax rate depends on her tax filing status and total income. 

For instance, if Elaine is single with taxable income up to $47,025, she’d owe zero capital gains on her stock sale! If her taxable income is over $47,025 but under $518,900, she’d owe 15% on her gain. Elaine could consult with a tax professional to estimate her tax liability on the potential stock sale before deciding whether to sell or keep it.

Owning an asset for less than a year means any capital gain is considered short-term, taxed at higher ordinary income rates, ranging from 10% to 37%. So, owning an asset for longer helps minimize taxes. 

Also, if you have a capital loss on an investment, you may be able to offset other gains or take a tax deduction, depending on your situation. But you can never claim a capital loss when selling a home.

What are home sale capital gains?

As I mentioned, selling your home for a profit also creates a capital gain for income taxes. However, if you follow specific IRS rules, there is a unique home sale gains exemption for up to $250,000 for singles and $500,000 for joint taxpayers. For instance, it must be your primary residence and you must have lived in the property for at least two of the previous five years.

For instance, if you purchased your home for $300,000 and sold it ten years later for $500,000, your entire $200,000 gain would be tax-free if you meet the ownership requirements. If you want to learn more, listen to podcast 826, What Tax Do I Owe on My Home Sale?.

What are investment dividends?

The second type of investment income you could have is from owning shares of dividend-paying stocks. A company can reinvest its profits into the business or pay it to shareholders as dividends. 

Not all stocks pay dividends, but many mature companies pay consistent dividends that can even increase over time. For instance, Caterpillar, Inc. (CAT) pays a dividend yield of 1.57%. The yield represents a stock’s annual dividend amount divided by its current price per share.

If you own a dividend-paying stock, you automatically receive a dividend when the company declares one. You can take dividends in cash or reinvest them into the company by purchasing more shares. 

Either way, you owe taxes if you own a dividend stock in a taxable brokerage account. For instance, if you receive $100 monthly from a dividend stock, you’ll receive a statement from the company at the end of the year showing income paid of $1,200.

Dividends can be “qualified” for special tax treatment if you own the investment for more than 60 days. That means you pay taxes based on the capital gains tax rates from 0% to 23.8%, depending on your total taxable income. 

As I mentioned, nonqualified dividends, or those you own for less than 60 days, get taxed at your ordinary tax rate, which is typically higher. And if you own a dividend stock in a retirement account, the income gets shielded from tax temporarily in a traditional account or forever in a Roth.

What is interest income?

The third type of investment income is interest, which can come from bank savings, a CD, or a bond investment and is usually taxed as ordinary income when owned in a taxable brokerage or bank account.

There’s an exception for interest on bonds issued by states and municipalities, which are exempt from federal income tax. You might also get a break on state income taxes on certain investments, such as Treasury bonds.

And speaking of states, be aware that your home state may have its own taxes on investment earnings in addition to the federal rates I’ve reviewed. So always speak with a local tax advisor about your situation if you have questions about investment income.

How to invest extra cash in retirement

Elaine also asked what to do with her cash if she sells her stock. Depending on her financial picture, she could add it to her savings, pay down any debt, invest it, or use it to reduce her future taxes. 

Assuming Elaine has no high-interest debt, she might want to boost her savings balance, which is a safe choice. Having at least a year’s worth of living expenses in an FDIC-insured high-yield savings account is wise. And if she already has enough savings, Elaine could shop for a higher-rate CD.

However, if Elaine feels good about her savings and retirement income, another option is to create a plan for Roth conversions over multiple years. That’s a strategy where you move money from a traditional retirement account, pay income taxes on the withdrawal, and move it to an after-tax Roth IRA. 

It’s a wise move if you believe your current tax rate is lower than it will be in the future. 

But it’s critical to be mindful of how Roth conversions increase your taxable income and have a plan to stay in the lowest possible tax bracket annually. It’s wise to consult a financial advisor to calculate Roth conversion thresholds.

Also, Elaine didn’t mention having a Roth IRA, so she’d need to open one. While her conversions would always be tax-free, she’d need to own the Roth IRA for at least five years before her account earnings would also be tax-free, no matter her age.

Depending on her comfort with risk, she could put her Roth conversions in a safe vehicle, like a CD or money market account. Or, if she wants more growth, she could invest in a total market index or exchange-traded fund inside the Roth IRA. 

If Elaine is considering leaving money to heirs, making them a beneficiary of a Roth IRA is an excellent way to pass along tax-free money to future generations.

This article originally appeared on Quickanddirtytips.com and was syndicated by MediaFeed.org.

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8 Ways to Maximize Your Investments With Robo-Advisors

8 Ways to Maximize Your Investments With Robo-Advisors

If you’re too busy to stay up-to-date on financial markets and investing strategies, one of the best ways to boost your returns with minimal effort is using a robo-investing platform. Whether your goal is to save for a new car soon, build a multimillion-dollar nest egg for retirement, or anything in between, I’ll review what a robo platform is and eight benefits of using one.

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Understanding eight primary benefits of robo-investing platforms can help you take the right amount of risk, cut fees, and meet your short- and long-term financial goals.

  1. You get SIPC protection.

Robo investing platforms offer features and technology you won’t find with traditional financial firms, and I’ll review many of them here. However, one benefit that’s the same is getting protection from the Securities Investor Protection Corporation (SIPC) for your robo accounts.

The SIPC protects customers of SIPC-member firms if the company fails and can’t repay their investments, like stocks, bonds, mutual funds, or cash. Therefore, if your robo platform goes out of business, the SIPC helps you recover up to $500,000, including up to $250,000 of lost cash.

However, the SIPC never covers losses due to market volatility or investment decline. 

Also, note that it’s different from FDIC (Federal Deposit Insurance Corporation) insurance, which participating banks offer. So, don’t confuse the SIPC with FDIC insurance, which covers up to $250,000 of your deposits per banking institution per account ownership category, such as individual or joint accounts.

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Another reason robo-investing platforms are just as safe as many investing companies is that they’re regulated by the Securities and Exchange Commission (SEC) as registered fiduciaries. A fiduciary is required by law to act in their customers’ best interests.

Note that many online brokerages are not fiduciaries. They operate as a transaction-based stock broker and are not required to act in your best interest. 

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Most robo-investing platforms offer various account types, such as high-yield savings, taxable brokerages, and tax-advantaged retirement accounts, like IRAs. I have all those accounts with Betterment, which has been my robo-advisor for decades. Another good platform to check out, especially for beginners, is Acorns.

For instance, my savings are for emergencies and planned short-term purchases. My brokerage is for medium-term goals, such as expenses I’ll have in more than about three years from now. And my IRAs are building wealth for the long term, so I have plenty of income in retirement.

Some robo platforms may also offer retirement plans for the self-employed, such as a solo 401(k) or SEP-IRA, which is the type I use. Or they may offer regular 401(k)s, which you could provide to employees if you run a small business. 

Ridofranz/istockphoto

Robo-investing is an automated way to build wealth using a portfolio of funds. The platforms allow you to choose your level of risk based on an initial intake questionnaire to consider your age, savings, and goals. Then, they choose various index or exchange-traded funds (ETFs) with underlying assets that match your risk profile. But you can always increase or decrease your desired risk level as needed.

Robo platforms exist to prevent you from losing money by picking individual stocks, which can be more of a gamble than an investment for the average person. Investing in funds means buying hundreds or thousands of underlying securities, such as stocks, bonds, and real estate. In other words, you purchase the returns of the market instead of just one company, such as Google or Disney, which cuts risk.

monkeybusinessimages/Istockphoto

The optimized combinations of funds used by robo platforms represent different asset classes. They might include domestic or international equities, bonds, real estate, or an entire index, such as the S&P 500 or the Wilshire 5000. While swaths of the market can undoubtedly decline, owning funds over a long period, such as at least five years, reduces your risk. 

For example, from 1973 to 2022, the US stock market returned an average of 11.7% annually. If you invested $10,000 in a total market index fund in 1973 and left it untouched, you’d have over $2.5 million today.

Assuming a more moderate average annual return of 7%, a $10,000 investment today will grow to about $76,000 if left alone for 30 years. But if you invest $10,000 annually, or about $833 a month, with a 7% return, you’ll have more than $1 million after 30 years.

Iuliia Zavalishina/istockphoto

In addition to making you a diversified investor, robo platforms aim to cut your expenses. They charge fees that are much lower than many human financial advisors. That’s because they use technology, like algorithms, to deliver their service at a lower cost and offer low-cost index funds and ETFs.

For example, an advisor charges about 1% to 2% of a portfolio value they manage annually. If the market allows you to earn 7%, and an advisor takes 2% off the top, you only make 5%. And, you still pay an advisory fee even in years when the market underperforms. The larger your portfolio, the smaller the management fee should be, but it still adds up.

Robo platforms may charge less than 0.35% annually, which is a bargain. For instance, if you have $100,000, your fee could be $350 a year or about $29 monthly.

You also pay fees for the funds in your portfolio, known as an expense ratio. They automatically get deducted from your balance, so many people mistakenly believe they don’t pay investing fees. Remember that no-fee investing doesn’t exist–you should expect to pay reasonable costs, even with a small portfolio. 

However, wise investors should do everything possible to minimize fees, especially during the accumulation phase of life, where you may not need specialized advice.

I’m not saying talented advisors shouldn’t be fairly compensated for their guidance and investment management services. But you’ll likely only need ongoing financial management if you have a large portfolio or are approaching or starting retirement. 

Ridofranz/istockphoto

Robo platforms routinely monitor the asset classes you own and rebalance them back to your intended proportion and risk tolerance. They sell fast-growing fund shares and buy slower-growing ones to keep the original shape of your portfolio.  

For example, if the stock market rises, your portfolio could become overweight with stocks, which are inherently riskier than most other asset classes. The solution is to sell shares of stock funds and purchase other asset classes, such as funds with bonds or cash, to ensure you’re not vulnerable to more investment risk than you want.

That makes robo-investing an excellent way to stick to a plan in mathematical detail. An algorithm won’t sell shares in a panic if prices go down or buy shares rising fast out of greed. It keeps you from trying to beat the market or doing something undisciplined with your money.

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Many robo platforms offer automated services to reduce your income taxes, known as tax-loss harvesting. It’s a strategy provided by most traditional investing companies, but it can be manual, time intensive, and therefore expensive compared to robo services.

Tax-loss harvesting is when you sell some investments as a capital loss to offset capital gains or other taxable income in your portfolio. It gives a typical investor who uses it a $3,000 deduction against their ordinary income tax. 

For example, if you have a 20% average tax rate, a $3,000 deduction would save you $600 annually. That’s likely more than enough to cover the annual fees a typical robo platform charges!

Tax-loss harvesting legally lowers your net taxable income if certain conditions are met and you use a taxable brokerage account. It’s not a strategy for retirement accounts because your taxes on gains are either deferred or tax-free when you make withdrawals.

Because robo platforms are software-based, they can make complicated tax-loss harvesting calculations and required trades at scale and for a low cost to customers. Your responsibility is to file the paperwork the platform sends you–Form 1099-Bopens pdf file to report capital gains and losses and 1099-DIVopens pdf file to report dividends–-with your tax return.

This article originally appeared on Quickanddirtytips.com and was syndicated by MediaFeed.org.

Jacob Wackerhausen/istockphoto

Bitcoin: Breaking Down the History (& Controversy)

https://www.msn.com/en-us/money/markets/bitcoin-breaking-down-the-history-controversy/ar-AA1o5Q2d

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Featured Image Credit: monkeybusinessimages/istockphoto.

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