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September, 2002 Tax Tip


Six Tax Savings Tips For Investors


A recent study revealed that the average mutual-fund investor in a taxable account loses 2.5 percent of his investment to taxes each year. That means a $10,000 investment growing over 10 years at 10 percent a year would gain just 7.5 percent a year, or lose more than $5,000 over the 10 years to taxes.  Taxes on individual stocks and bonds can be just as devastating.

But investors can fight back!   Here are a few ways that investors can reduce this tax burden.

1.  Stop trading . Sales of stocks, bonds and mutual funds can incur taxes on your capital gains, or the amount your investment has risen, regardless of dividends, interest and the original purchase price. The longer you can keep your money in that investment, the longer those capital gains will work for you, earning more money.

2.  If you are fortunate enough to incur capital gains, consider offsetting the gains with capital losses.  A loss occurs when you sell an investment, minus its interest and dividends, at less than the price you bought it for. Some times it makes sense to sell a loser you no longer want and offset capital gains elsewhere.

3.  When it comes to capital gains, mutual funds pose a special problem. Even if you don't sell them, you can incur capital gains, because the managers of these funds may sell investments at a gain during the course of the investment year. Fund shareholders must pay the tax on those gains.  To avoid or minimize this,  invest in mutual funds that generate few taxes.  Look for "tax- managed" funds, or those funds that say in their prospectus that they attempt to keep taxes low.   Also, look for funds with relatively good after-tax returns, as these may be indicative that a fund may continue to generate low taxes. These figures, too, can be found in a fund's prospectus.

4.  Take full advantage of tax-advantaged accounts, like 401(k)s and Individual Retirement Accounts (IRAs) to defer taxes. Dividends, interest and capital gains in these accounts are tax-deferred. With 401(k)s and Traditional IRAs, contributions can be tax deductible. With a Roth IRA, the money is withdrawn in retirement tax free.

5.  For bond investors in taxable accounts, consider municipal bonds. These are free of federal taxes and, in many states, are not taxed to residents of  the issuing state as well.  Although these bonds pay lower rates of interest than corporate bonds or Treasuries, the tax-free interest makes them worthwhile for many investors in moderate as well as high tax brackets.

6.  Some investors may also want to explore variable annuities, which act like mutual funds but allow money to grow tax-free. Variable annuities are an insurance product, however, and, because of that, they charge investors higher annual fees than do most mutual funds. Still, for some tax-conscious investors, they may prove worthwhile.

I would be happy to review your investment portfolio with you, and it is also recommended that you discuss the tax burden with your investment advisor.


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