Four Ways That Taxes Influence Your Investments

Four Ways That Taxes Influence Your Investments

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Taxes definitely influence investors’ decision-making process. For example, investors don’t receive the full benefit of the taxable bond’s coupon rate. Coupon income, unless sheltered in a tax-deferred account like a retirement plan or annuity, will add to the investor’s total income. Tax-exempt bonds, on the other hand, pay lower nominal coupon rates but help investors save on taxes. To determine which yield is actually best depends upon the investment’s real return after taxes.

In comparison, successful short-term trading in some securities, e.g. equity options or foreign exchange contracts, add to the investor’s tax bill and present high levels of capital risk. Purchasing less risky blue chip stocks–companies whose products and services are established–can help investors earn dividend income and, eventually, long-term capital gains if held in the portfolio for more than one year. Of course, all equities are perceived as higher risk investments than bonds and insurance products like annuities. Here are four ways that taxes influence your investments:

Tax Exempt Bonds

Yields, or current coupon interest divided by bond price, are quite low. For this reason, some experts warn investors that bond prices are likely to decline as interest rates increase and that current coupon rates are too low to justify the risk an investor assumes over the bond’s life.

For example, ten year bond pays a 1.75 percent tax-free yield when an investor purchases it. Interest rates start to increase. To compensate for higher yields of new issues, existing bond issues decrease in price. Investors buying long-term bonds should prepare to hold them to maturity, at which time the investment grade issuer repays the bondholder at par (100 percent).

According to "Investing in the High Yield Municipal Market," most municipal bond issuers are not rated A or better. Due diligence is required to purchase them.

Annuities

Investors preparing for retirement usually prefer to take profits in risk-bearing securities, such as equities, and purchase income-producing securities like bonds. Because both taxable and tax-exempt bond rates remain at near historically low levels, annuities underwritten by the nation’s top insurance companies offer competitive tax-deferred income. If you aren’t sure what annuities can offer you, there are different learning guides online. To see how taxes would influence your investment look at the annuity tax calculation and find out what works best for you.

Short-Term Trading

Aside from much higher levels of capital risk associated with short-term trading in stocks, options or almost any security, aggressive buy and sell traders create higher amounts of short-term capital gains. Taxes on gains are double those of long-term gains, and decrease the investor’s after-tax "real" return.

Short-term capital gains receive no special tax treatment. Because they are short-term holdings (one year or less), they are treated as ‘ordinary income’ and taxed at the same rate (10 percent to 39.6 percent).

Blue Chip Stocks

All equity investments, including large capitalization blue chip stocks, rise and fall with the stock market. Many investment advisers recommend a long-term buy and hold strategy for making money in stocks. Although blue-chip stocks are perceived as less risky than smaller high growth stocks, they are still equity investments. Unless held for a minimum of one year and a day, profits in stock investments are taxed as regular income.

Ronald R. Mueller ("It’s How Much You Keep That Counts!") writes about the ways that taxes influence financial planning and investment decisions. Taxation affects the investor whether he or she plans for the impact of taxes. Tax planning and using tax-deferred investment strategies, helps many investors achieve an income they cannot outlive.

About the Author: Kandace Heller is a freelance writer in Orlando, Florida. She has a passion for finance and loves to share tips with others. Kandace got her information on annuity tax calculation from insidersannuityguide.com.

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