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Why Tax Knowledge Is Power

When it comes to investing and financial planning, and probably just about anything else in life, knowledge is power.  It’s true.

Even with something as complicated as taxes, a little bit of knowledge can go a long way.  If you can legally pay less than what you’re currently paying, that’s a good thing, isn’t it?  So the more you know about taxes, tax brackets, tax rates, and how certain accounts like your 401(k) or your personal brokerage account are taxed to you, the more power you have, and the more you may be able to save.

You can own an asset – like stocks, for example – in several different types of accounts.  You can own them personally through a brokerage house, or in your traditional IRA, Roth IRA, or in your 401(k).  When you sell those stocks and take possession of the money, if there’s any gain at all, that gain could either be 100% taxable at one rate, partially taxable at another rate, or not taxable at all.  It all depends on which account you sold it from.

This is where knowledge becomes power.

Let’s take a hypothetical example. Suppose someone paid $10,000 for some stock many years ago.  And let’s just say they got lucky and it’s now worth $50,000.  If they sell that stock today, there would be a $40,000 gain.  How much in taxes would they have to pay on that gain?  That depends on which account held that stock.  If it’s in a 401(k), there’s no tax today, but the entire $50,000 will be 100% taxable at their ordinary income rate once they take it out of the tax deferred account.  All of it.  If they have it in a regular brokerage account, then just the $40,000 gain will be taxable today, but at the lower capital gains tax rate.  If it’s in a Roth IRA and the individual is older than 59½, it will most likely be entirely tax free.

This doesn’t mean that owning stocks in your 401(k) is always bad, or that having your equities in a Roth is always best.  Did you know there are ways to take as much as $26,000 from your 401(k) without paying any taxes at all?  We devoted an entire video to that strategy, which you find by clicking here on the link.

But you can see the importance of knowing how assets located in different types of accounts are taxed.  By using what’s known as an “asset location” strategy, you may be able to dramatically decrease the amount you’ll ultimately pay in taxes.  In fact, an article in Forbes last year suggested it could make as much as a 20% difference to your portfolio over the long run.

Taxes are one of the biggest drags on your portfolio’s overall performance.  That’s why it’s crucial that you make tax management a priority in your financial plan.  This is something we do every single day here at Lucia Capital Group, so if you want to find out how tax-efficient you are right now, just give us a call.  We’re here to help.

Important Information:

The information provided should not be considered specific tax, legal, or investment advice and is not specific to any individual’s personal circumstances. To the extent that this material concerns tax matters, it is not intended or written to be used, and cannot be used, by a taxpayer for the purpose of avoiding penalties that may be imposed by law. Each taxpayer should seek independent advice from a tax professional based on his or her individual circumstances. This material was gathered from sources believed to be reliable, however, its accuracy cannot be guaranteed.

Different types of investments and/or investment strategies involve varying levels of risk, and there can be no assurance that any specific investment or investment strategy (including the investments purchased and/or investment strategies devised by LCG) will be either suitable or profitable for a client's or prospective client's portfolio, thus, investments may result in a loss of principal. Accordingly, no client or prospective client should assume that the presentation (or any component thereof) serves as the receipt of, or a substitute for, personalized advice from LCG or from any other investment professional.

IRA withdrawals will be taxed at ordinary income rates. Withdrawals prior to age 59½ may also be subject to a 10% penalty tax.

Roth IRA distributions of principal from a Roth IRA are tax-free; however, any earnings will be taxed at ordinary income rates and a 10% penalty tax will apply if withdrawn prior to age 59½ or within five years of the date the Roth IRA was established, whichever is longer.

Case studies are hypothetical, are for illustrative purposes only, are not guaranteed and subject to potential federal and state law amendments. There is no guarantee that you will achieve the results discussed or illustrated.

Rick Plum is a registered representative of, and offer securities through, Lucia Securities, LLC, a registered broker/dealer, member FINRA/SIPC. Advisory services offered through Lucia Capital Group, a registered investment advisor, and an affiliate of Lucia Securities, LLC. Registration with the SEC does not imply a certain level of skill or training.

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