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Taxes – Pay Now or Pay Later

No matter what your income, it is important to think about how your tax situation might affect your investment decisions. Annuities and tax-qualified investment accounts allow you to defer paying taxes on earnings and gains in the accounts. Other types of accounts require that you report the gains and dividends as they are earned. Both types of accounts may have a place in your overall investment strategy.

Dividends, Interest, and Capital Gains

Generally, when a dividend is paid to you on a stock you own, or you receive a capital gain when you sell a stock at a profit, you owe income taxes. The interest earned and capital gains received from bonds are also subject to income taxes. This is true of most mutual funds, too. Shareholders must pay income taxes on their share of the dividends, interest, and capital gains reported by a mutual fund, whether reinvested in the fund or not. Of course, if your fund account is set up through a tax-qualified plan such as an IRA, 401(k), or 403(b) program, taxes may be deferred until you receive a retirement distribution from the fund.

Tax Deferral

As an investor, you might want to defer paying income taxes as long as possible. Tax deferral means that as the value of your initial investment increases, the money you would have otherwise paid in taxes on those earnings or capital gains also grows.

Investing through your employer-sponsored 401(k), 403(b), or other qualified retirement plan is one way to defer taxes. You may also defer taxes by putting some of your investments into a traditional individual retirement account (IRA). Dividends and capital gains are not taxed until you withdraw the funds from any of these retirement accounts. In a Roth IRA earnings accumulate tax-free and distributions are also tax-free. Remember, in most cases, there are IRS penalties for withdrawing funds from a retirement plan before age 59½.

When thinking about your overall financial future, you may want to consider purchasing a fixed or variable annuity. A fixed annuity guarantees your principal and earns a set interest rate for a specified period. A variable annuity allows you to put your deposits in a variety of investment options that may put your principal at risk and pay different rates of return. Earnings in annuities are not taxed during the accumulation period. Taxes are deferred until you take a withdrawal or receive payments. Once you are ready to begin receiving payments, an annuity offers several income options that are guaranteed to last a lifetime. An annuity also helps protect the future of your loved ones through death benefit provisions. Unlike life insurance, earnings accumulated and paid out to the beneficiary of an annuity may be taxable.

When providing for your beneficiaries is an important consideration, a variable universal life insurance policy is one way for you to capture the power of investing along with the protection only life insurance can give. With this type of insurance, your premium payments are flexible and may vary within certain guidelines. You determine where your premium is invested from an array of investment choices. Variable universal life insurance provides tax-deferred accumulation of assets, tax-favored access to policy values, and income tax-free death benefits paid to your designated beneficiaries.

Another way that you might lessen the income tax obligation on interest earnings is by purchasing municipal bonds. Generally, you must have a substantial amount to invest to purchase a bond. An affordable way to invest in municipal bonds is through a tax-free bond mutual fund. The income earned in the fund accumulates free from federal and, in some cases, state and local income taxes. Any capital gains realized at the sale of your shares in the fund are taxable in the year of the sale.

Need help planning your taxes? Use our Tax Calculators to get a handle on things.

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Last Updated: 12/14/2017