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Top 5 Tax Efficient Investing Tips

You might not think that investing in general is a great way to reduce the money you owe for taxes each year. And if your portfolio is full of stocks and bonds that are busily earning you money year upon year then you could be right. But there are ways to invest that can actually make your money work harder for you not only by way of earnings, but also when it comes time to file your annual income tax. Here are a few tips you might want to look into.

  1. Contribute to a 401K. The best way to save money on taxation when you invest is to look for tax-advantaged accounts, and under this banner you’ll find tax-deferred accounts. In case you don’t know what qualifies, you need look no further than the 401K provided by your employer. The money you contribute to this account is deposited before taxes, meaning that you’re not being taxed on all the money you’re earning (which is fantastic news). And although you’ll have to pay when you withdraw the money (at which time it will be taxed as income) you’ll have more tax-free dollars earning you money until that point. This is especially true when your employer has a matching program by which they contribute matching funds to your 401K.
  2. Start a Roth IRA. This is just another type of tax-deferred account, but it’s a little different from your standard 401K. For one thing, the amount of tax-deferred income you can contribute annually is restricted to $5,000 (or $6,000 if you’re over 50) as of this year. You can contribute more, but you won’t be able to use the excess as a write-off come tax time. But a Roth IRA still offers you the benefits of compound interest and it increases your nest egg for retirement.
  3. Buy a home. You are probably aware of the fact that purchasing property for your primary residence is an excellent investment in and of itself simply because you own an asset that is likely to show a significant return down the road (based on intrinsic value). However, it can also be a major boon at tax time since you can deduct any interest you pay on your primary residence. The same may not be true of additional properties, however, so don’t count on being able to write off the interest you pay on a second or third property, especially if you’re using it for passive income (i.e. renters).
  4. Avoid REITs. If you’re not concerned about the money you’ll owe in taxes, then REITs (real estate investment trusts) could provide you with an excellent opportunity to grow your capital. Unfortunately, the dividends you earn tend to be taxed as regular income, unlike other types of stock dividends, which generally enjoy a lower rate of taxation. It’s something to consider if you’re counting every penny.
  5. Use the foreign tax credit. When your money is leaving the UK, China, or other countries where you’ve invested it, you may find that you are able to gain some traction with the IRS. Not all international stock funds are subject to the foreign tax credit, but there are some occasions where you can hold international stocks in taxable accounts, pay foreign taxes on earnings, and get a break on domestic taxation in the process.
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