Published April 2005

Three tax-smart moves
for 2005 and beyond

Now that tax season is coming to an end, you may want to review your returns for opportunities to brighten your tax picture for next year. Specifically, are you paying too heavy a load on your investment income?

If so, you may want to explore some “tax smart” moves for 2005 and future years. Consider these techniques: tax-deferred investing, tax-free investing and tax-efficient investing. Let’s take a look at all three.

Tax-deferred investing
When you invest in a tax-deferred vehicle, you pay no taxes on your earnings until you start taking withdrawals (withdrawals prior to 59 may be subject to a 10 percent penalty), so your money can grow faster than it would if placed in an investment where your earnings were taxed each year. You have several tax-deferred options available, including the following:

• 401(k) — It’s almost always a good idea to contribute as much as you can afford to your 401(k) or other employer-sponsored retirement plan. (In 2005, you can put in up to $14,000 to your 401(k), or $18,000 if you’re 50 or older.) Your contributions are made with pre-tax dollars, so, the more you put in, the more you’ll be able to reduce the tax liability on your compensation. You get the benefit of tax-deferred earnings growth. And, your employer may match part of your contributions.
• Traditional IRA — In 2005, you can contribute up to $4,000 to a traditional IRA, or $4,500 if you’re 50 or older. Depending on your income level, your contributions may be tax deductible, and your earnings will grow on a tax-deferred basis. Plus, you can hold a wide range of investment types in your IRA, including stocks, bonds, certificates of deposit, government securities and even annuities.

Tax-free investing
One way to help reduce your investment taxes is to avoid paying taxes altogether. You can do that using municipal bonds and the Roth IRA.

• Municipal bonds — When you invest in municipal bonds, your interest income is exempt from federal taxation — and possibly state and local taxation as well. (However, some municipal bonds are subject to the alternative minimum tax.)
• Roth IRAs — Your Roth IRA earnings grow tax-free as long as you’ve had your account for at least five years and you don’t begin taking withdrawals until you’re 59-1/2. Roth IRA contribution limits and investment types are the same as those for the traditional IRA; however, certain income restrictions may affect your eligibility to fund a Roth IRA.

Tax-efficient investing
Income taxes aren’t the only types of taxes associated with investing; you also may have to pay capital gains taxes. That’s why it makes sense to be a “buy and hold” investor. If you hold your stocks for more than one year before selling them, then your gains will only be subject to a maximum capital gains rate of 15 percent (effective through Dec. 31, 2008). But if you sell your stocks within a year of buying them, then your gains will be taxed at your ordinary income tax rate.

To see if the ideas mentioned above are suitable for your individual needs, consult with your investment and tax advisers. But take action soon — the quicker you start making tax-smart investments, the better your results will be.

Eric Cumley is a Certified Financial Planner and investment representative with Edward Jones in south Everett. He can be reached at 425-353-2322.

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