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Yes, Tax Knowledge Is Important

When it comes to investing and financial planning, and probably just life in general, being well-informed about a particular topic gives you an edge that others don’t have. You’ve heard the saying “knowledge is power?” It’s not just a saying, it’s true. 

Even with something as complicated as taxes, just a little bit of knowledge can go a long way. If you know of a method that will legally allow you to pay less in taxes than what you’re currently paying, that’s a good thing! So the more you know about taxes, tax rates, tax brackets, 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. 

We’ve mentioned before about how 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 you can own them 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, or partially taxable at another rate, or not taxable to you at all.  It just depends on which account you that asset was in. 

This is where knowledge becomes power. 

Here’s an example

Let’s take a hypothetical example. Suppose someone paid $10,000 for some stock many years ago, and it managed to grow very nicely over the years and is now worth $50,000. If they sell that stock today, there would be a $40,000 gain. But how much of that $40,000 gain will be taxable to them? That depends on which account held that stock.   

If that gain happened in their 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 – earnings and their original contribution. If that stock was held in a regular brokerage account, then just the $40,000 of gain will be taxable today, and it will be taxed 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. 

So does this mean that owning stocks in your 401(k) is always bad because you’ll pay taxes, or that having your equities in a tax-free Roth is always best?  Not necessarily. There are actually ways for a married couple to take $27,700 or more if they are 65 or older from their 401(k) this year without paying any taxes at all. 

Knowledge is power

Here again, knowledge is power. 

This really illustrates 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 suggested it could make as much as a 20% difference to your portfolio over the long run. 

Since taxes are one of the biggest drags on your portfolio’s overall performance, it’s vital that you make tax management a priority in your financial plan. We do this for our clients every single day here at Lucia Capital Group, so if you want to find out how tax-efficient you are right now, or if there’s maybe more you could be doing, schedule an appointment.  As always, 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. Each taxpayer should seek independent advice from a tax professional based on his or her individual circumstances.

IRA withdrawals will be taxed at ordinary income rates. Withdrawals prior to age 59½ may also

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.

Examples cited 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 with, and securities and advisory services offered through LPL Financial, a registered investment advisor and member FINRA/SIPC. The investment professionals are affiliated with LPL Financial and are conducting business using the name Lucia Capital Group, a separate entity from LPL Financial.

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