Tax Saving Advice for Mutual Funds

One of the factors that greatly hurt the money in your mutual fund is taxes. In order to minimize their negative effects, follow these advices:

• Contribute as much as possible to your employer-sponsored retirement plan.

  Company-sponsored retirement plans carry two advantages. First of all, the contributions you make are before taxes have been deducted. Therefore, you reduce your taxable income and as a result pay less tax. Secondly, retirement accounts are famous for their compounding advantage. The money will grow without being interrupted by taxes.

  Since taxes represent an expense that decreases your returns, you should try to use every investment tool available in order to minimize them. Additionally, the higher the tax bracket in which you are, the higher the bite of Uncle Sam.

• Open an IRA account.

  IRAs provide a good way to save from your taxes and at the same time accumulate money. You can choose from traditional IRA and a Roth IRA. Under traditional IRA, the contributions you make are tax deductible and provide tax-exempt investment growth. If you withdraw money before you reach the age of 59 ½ you will be subject to penalties. On the other hand, investments in a Roth IRA enjoy free of taxation growth. However, Roth IRA contributions are never deductible. After reaching the age of 59 ½ you are allowed to retrieve money from your Roth IRA account without incurring any taxes or penalties. There are contribution limits that are established by the IRS, which are adjusted each year. 

• Make sure that the right funds are in the right accounts with respect to taxes.

  Since different types of mutual funds have different tax implications, you should carefully make your asset allocation. For instance, most tax advisors recommend the inclusion of bond funds and money market funds in a non-taxable account, whereas stock funds in a taxable account.

  You should identify the type and frequency of income generation of the particular mutual funds you want to hold and allocate them in the corresponding accounts. The general rule is to put mutual funds that give as return long-term capital gains in a taxable account, since they enjoy a more tax favorable attitude. On the other hand, part of the non-taxable account should be made mutual funds that return income.

  You have another option of keeping your money from bond and money market funds away from Uncle Sam. That is to purchase the exempt from federal income tax money market or bond funds. Since with the increase in your tax bracket you are liable to more taxes, money market and bond funds become even more attractive place to park your money.

Some mutual funds have attempted to give their shareholders after-tax returns. This was done in order to make shareholders better understand the effects of taxes on their income. Finally, when selecting a mutual fund and deciding on the account in which to put it, consider the magnitude of the returns that is possible to be lost as a result of taxes. Consult your tax advisor whenever you meet any difficulties in deciding which mutual fund goes where.

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