For educational and informational purposes only, This is not a recommendation to buy, sell or invest. Please consult your advisor and tax consultant.

Having a solid knowledge of tax strategies and handling your taxes is part of sound financial health. Some taxes can be deferred while others can be managed through intelligent investing. By understanding and laying some well-thought-out groundwork for your taxes, you can manage the influence of these taxes on your monetary efforts. On the other hand, ignoring the tax ramifications in your investment portfolio could damage your financial health. However, with careful preparation, you can decrease the effect of taxes on your investment revenues.

Most of us are familiar with the Ben Franklin quote, “nothing is certain except death and taxes.” And he was correct; taxes are part of our everyday lives. The IRS processed roughly 128.8 million returns in 2017 with an average refund of $2,763—that’s over $350 billion in tax refunds. These taxes have made some serious progress since their conception in the 1900s.
Federal income tax was instituted in 1913 after the 16th Amendment to the Constitution was implemented.

What makes the 16th Amendment so important?

It allowed the federal government to levy income tax from the American public. Taxes on property were considered direct taxes which meant the federal government would need to divide these taxes among the states. Thus the first 1040 Form was born.

How Does This Affect Us Today?

As of 2018, households in the top 20% will pay 87% of total income taxes. Those in the top 20% have an income of roughly $150,000 or more which is about 52% of total income earned. The bottom 80% pays roughly 13% of total federal income taxes, while the bottom 20% have a negative tax rate. A negative tax rate simply means that the bottom 20% receives higher returns from the government because of larger refundable tax credits.

Types of Taxes

While the general population is familiar with federal tax, Americans are responsible for paying a multitude of diverse taxes. Here are some of the most common taxes outside of federal income tax:

1. Sales taxes – These are taxes paid on purchased goods and services; these amounts vary by state and, in some places, by city. One of the highest in state tax is Louisiana at 10.02% while the lowest is Colorado at 2.9%.

2. Payroll taxes – Employees and employers have to pay Social Security and Medicare tax. For Social Security, the employee and employer pay 6.2% of their earnings, while 1.45% of wages goes toward Medicare. Thus 7.65% is paid in payroll taxes every year.

3. Excise taxes – Gas, beer, liquor, and cigarettes all fall under this category. These taxes are often are intended to help raise money while discouraging harmful behaviors (such as smoking and drinking). An excise tax is normally combined with sales taxes on a purchase.

4. Property taxes – Property taxes are based on current market value and help fund local services such as road maintenance and construction. In many cases, property taxes are deductible.

5. Estate taxes – Estates surpassing $5.34 million are subject to tax by the federal government. Simply put, you are taxed for the ability to transfer assets at your time of death.
There are a number of other taxes in addition to the 5 listed above, so it’s a wise choice to consider using a professional to help manage these taxes with a system that works best for your exact needs.

One important thing to contemplate is that as federal administrations shift, tax rules shift as well. For example, in 2018 there were at least 10 changes made to tax guidelines including personal exemptions, standard deductions, estate tax and state tax that had a high impact on tax returns. Each time these shifts occur, your investment portfolio has the potential to be affected either positively or negatively.


Tax-favored investing encompasses the following areas:

  • Tax-exempt investments
  • Tax-deferred investments

Tax-exempt investments, such as municipal bonds and some money market funds, allow your money to mature and grow while being exempt from federal taxes. With tax-deferred investments, taxes are deferred until you withdraw your money. This may include retirement plans, annuities, and life insurance. The best way to illustrate tax-exempt and tax-deferred investments is to look at a few examples.

Bonds – Tax-Exempt Investment

The municipal bond market is enormous and provides a plethora of tax-exempt opportunities. These bonds are issued by state and local governments in order to raise money for public projects such as construction and maintenance and hospitals and schools. The bond issuer sells the bond to the bondholder in exchange for a fixed amount of money that earns interest. Put simply, State and local governments borrow money and pay interest on the money borrowed. Generally, interest paid is free of federal income taxes and sometimes free of state and local tax.

Because of their diversity, a tax-free municipal bond can be especially advantageous for those in high-income brackets and those looking to generate tax-free income, especially since these bonds have no annual costs.

Retirement Plans – Tax-Deferred Investment

Retirement plans such as 401(k)s and traditional IRAs are among the most popular tax-deferred investment options. These retirement plans allow their holders to make pre-tax contributions.

401(k) – Pre-tax contributions are subtracted from pay before taxes are calculated. Accrued taxes are deferred, leaving more money in the account and putting more money toward potential returns.

Some things to keep in mind are:

  • Employers may match employee contributions.
  • Earnings are taxed when withdrawn from a plan.
  • Withdrawals made before age 59½, may be subject to a federal income tax penalty.

IRA – An IRA, also known as an Individual Retirement Account is a savings vessel that offers tax breaks for those who are investing money specifically for retirement.

With IRAs:

  • Contributions can be partly or fully withdrawn.
  • Distributions from traditional IRAs are taxed as ordinary income.
  • Withdrawals are tax-free but contributions to a Roth IRA are not deductible.
  • Annuities – Tax-Deferred Investment

Simply put, an annuity is an agreement with an insurance company. They are generally used to save for retirement and/or create income payments in lieu of a paycheck.

There are two elementary types of annuities:

Deferred – Deferred annuities are meant for long-standing growth. This money grows tax-deferred to deliver an income flow during retirement. Premiums accrue interest during the growth phase and are not taxed until withdrawn.

Immediate – Immediate annuities deliver revenue right away and provide a reliable income generated over a number of years. An individual is permitted to collect regular income that is guaranteed by the insurance company as soon as the premium dues are paid.

Annuities can also be bought within an IRA, which is a creative, yet effective investment strategy.

Though an annuity might have additional costs (such as admin and management fees), it also offers guarantees that are unavailable within an IRA. For example, an annuity can offer:

  • Death benefits for family and heirs
  • Consistent lifetime income

However, it is important to note that when a deferred annuity funds an IRA, it does not offer extra tax deferment since tax deferment applies to the IRA only.

Life insurance – Tax-Deferred Investment

Cash-value life insurance policies are purchased through an insurance company. A premium is paid in exchange for benefits upon the policyholder’s death. These policies also build a cash reserve that pays a rate of return which is tax-deferred.

Another benefit of many life insurance policies is that they will lend individuals a share of the policy’s cash value under advantageous terms. Additionally, interest payments made on the loan goes directly back into the cash value of the policy.

Several factors affect the price and accessibility of life insurance including but not limited to:

  • Heath
  • Age
  • Type insurance purchased
  • Amount of insurance purchased

Life insurance policies do incur expenses and if a policy is given up early, the policyholder is subject to surrender fees and income tax consequences.

A Final Note

Efficiently handling your tax obligations is a lasting process. The above just scratches the surface of tax investments and that’s a lot of exemptions, deferments, fees, and charges to think about—and that’s okay because we’re here to guide you through it every step of the way and shed some light on your investment options.

For those at the top of their earning potential, investing in a tax-exempt or tax-deferred plan can mean more savings and larger tax breaks. When saving for retirement, an investor should attempt to take full advantage of prospective returns on investments by using tax breaks to their full capacity as a vital piece of the retirement puzzle.

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