We all dread April 15th, the day that Uncle Sam takes a chunk out of our checking accounts. However, there are three ways, including the utilization of exchange traded funds (ETFs), to make life a little less taxing.
1. The first way to minimize one’s tax liability is understanding the very complicated Internal Revenue Code. When it comes to investments, it is imperative to understand the internal trading cost of fund holdings by portfolio managers and the trading costs of mutual fund shares by the investor, states Ron DeLegge of ETF Guide.
Additionally, investors must keep in mind investment holding periods. Regarding capital gains on investments, the IRS taxes them based on how long the investment has been held. Short term-capital gains, those that have been held under one year, are taxed at ordinary income rates, where as long-term capital gains, those held longer than one year, are taxed at a much more favorable rate of 15%.
2. The second way to lower your tax bill is to coordinate your investments. This can be done through proper asset location by holding the right asset classes in the right places, whether it be in a tax-deferred account, such as a 401(k), or a taxable account.
3. Lastly, proper utilization of ETFs will distribute little or no capital gains and improve tax efficiency of a portfolio. A study conducted by Morningstar indicated that over the past five years , only two ETFs out of 27 distributed capital gains while just one did so over the past 10 years.
When choosing which ETFs to use, remember to do your homework because not all of them are treated equally.
Kevin Grewal contributed to this article.
The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.