Saving for retirement is all about investing, and no matter how you go about it, you’re going to end up paying taxes on what you save and earn. Taxes on capital gains can eat up a significant portion of your earnings each year.
When you’re building wealth and planning for retirement, it’s important to not leave any money on the table. That’s why it’s important to point out that a fiduciary financial advisor can help you optimize a tax strategy and identify savings opportunities to lower your tax liability.
An advisor can also help you manage assets and plan for retirement, so you can worry less about meeting your financial goals. According to a 2021 Fidelity study, financial advice can add between 1.5% and 4% to account growth over extended periods.1
Handing over a chunk of your profit can be painful. Thankfully, there are a few ways that you can reduce the amount of capital gains taxes you will pay after selling an asset.
Investing involves risk and no situation is the same. This is in no way intended as a personal recommendation and investment decisions are solely those of the reader.
Choose Long-Term Investments
Capital gains can be classified as either short-term or long-term, each of which has its own tax rates.
Assets you have held for less than a year are considered short-term. When it comes to earning short-term gains, expect to be taxed at your ordinary tax rate. This can be as high as 37%, depending on your total taxable income.
If you want to avoid that, you should consider choosing long-term investments instead. By holding an investment for a year or more, you will qualify for long-term capital gains tax rates.
Most long-term capital gains will see a tax rate of no more than 15%, though certain assets (like coins and art) can be taxed at a rate up to 28%. Depending on your income, you may even qualify for capital gains tax rates as low as 0%.
Take Advantage of Tax-Deferred Retirement Plans
Your retirement accounts likely make up a bulk of your savings and future assets. It’s wise to optimize these as best you can by utilizing tax-deferred (and tax-exempt) plans, to save yourself from added capital gains taxes.
When contributing to a tax-deferred retirement plan, such as a 401(k) or traditional IRA, you’ll receive a tax deduction on your contributions in the current tax year. This can save you money on your income taxes today, as well as help you save even more toward the future.
Your money will also continue to grow over time. When you’re finally ready to sell your investments and withdraw, any growth in the account is taxed at your ordinary income rate, rather than being subject to capital gains like other investment accounts.
A tax-exempt account, such as a Roth IRA, doesn’t offer any tax benefits today, but grows tax-free until retirement. When you’re ready to use the money, your funds (and growth) can also be withdrawn tax-free, helping you avoid capital gains yet again.
Offset Your Gains
If you hold a number of different assets, you may be able to offset some of your gains with any applicable losses, allowing you to avoid a portion of your capital gains taxes.
For instance, if you have one investment that is down by $3,000 and another up by $5,000, selling both will help you reduce your gains. You would only be subject to capital gains taxes on the difference – or $2,000 – rather than the full $5,000 gain of the second investment.
Another offset strategy is tax-loss harvesting. With this method, you can carry over losses from one tax year into the next, to help offset future gains. Tax loss harvesting only applies if your losses in a given year exceed your total gains.
If you’re looking for a way to decrease your tax burden, we recommend finding a financial advisor. They can help you understand your options and look for ways to save money on your tax bill, make smart investments and plan for retirement.
If you need help finding a financial advisor, we created a free quiz to help Americans find and vet qualified financial advisors who serve their area.
This quiz asks you a few questions, then matches you with up to three fiduciary financial advisors. You can compare your advisor matches based on their specialty, pricing, and more. You even earn 3 free consultations with each of our matches, so you can compare them and be fully prepared to pick a financial advisor.
The hypothetical study discussed above assumes that professional financial advice can add between 1.5% and 4% to portfolio returns over the long term, depending on the time period and how returns are calculated and is based on the Fidelity Whitepaper “Why work with a financial advisor, November, 2021”. Please carefully review the methodologies employed in the Fidelity Whitepaper.
The value of professional investment advice is only an illustrative estimate and varies with each unique client’s individual circumstances and portfolio composition. Carefully consider your investment objectives, risk factors, and perform your own due diligence before choosing an investment adviser..1
Helping people make smart financial decisions
When you own an investment or other asset – such as real estate, land, a business or stocks, for example – and later sell that asset for a profit, you have realized capital gains. The tax that is then levied on the profit portion of your sale is called capital gains tax.
Depending on how your gains are classified, and your total taxable income for the year, your capital gains tax rate can vary. This percentage could be as low as 0% or as high as your ordinary tax rate. Consider consulting a financial advisor to determine how your gains will be classified so you can know what to expect when taxes are due. Click here to get matched with up to three advisors who serve your area.
Source: How to Avoid Capital Gains Tax
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- Tax Evasion and Capital Gains Taxation”. American Economic Review. 77 (2): 234–239. JSTOR 1805456 – via JSTOR.
- The determinants of capital gains tax compliance: evidence from the RJR Nabisco leveraged buyout”. Journal of Public Economics. 84: 47–74. doi:10.1016/S0047-2727(01)00099-8 – via ScienceDirect.
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