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Keep your Investment Taxes to a Minimum

- Alan Lavine and Gail Liberman

U.S. mutual fund investors paid an estimate $8.6 billion in taxes in 2002, according to a study by Lipper Inc., a New York-based research firm.

Over the last 10 years, taxable stock and bond fund shareholders gave up 1.5 percentage points to 1.8 percentage points in total returns due to taxes. Total return measures the percentage increase or decrease in the value of your investment, including reinvestment of dividends and capital gains.

That means that if your mutual fund registered a total return of 7.2 percent annually, after taxes you earned just 5.4 percent annually.

Twenty-five percent of your earnings went to Uncle Sam!

There are a number of steps you can take to avoid being hit by the tax man. Perhaps the easiest is to make sure you keep your income investments and stock funds that generate capital gains in your tax-deferred retirement accounts or annuities. Look at IRAs, Roth IRAs or 401 (k) company pension plans. Keep tax-free bonds and low dividend-yielding stock funds in your taxable accounts.

Some other ideas:

Invest in annuities. Your money grows tax-deferred until you take distributions when you retire. You can invest in fixed annuities, which pay a set rate of interest for a specific term. Or, you can sock money into variable annuities, which let you to invest in stock and bond funds.

Consider cash value life insurance. The purpose of insurance is to provide money to your love ones when you are not around. The earnings in your cash value life insurance policy are not taxed, unless you cash out the policy. But you can borrow against the cash value tax-free.

If you are in at least the 27 percent tax bracket, invest in municipal bonds or municipal bond funds. The income is not taxed.

Invest in tax-managed mutual funds in your taxable accounts. These stock funds use tactics to reduce taxes.

Take advantage of tax loss selling strategies to write off investment losses against gains. Talk to your accountant about what you can do.

If you have sizable estate worth more than $1 million, talk to a financial planner about tax and estate planning strategies to reduce your taxes.


Alan Lavine and Gail Liberman are husband and wife columnist and authors of The Complete Idiot's Guide To Making Money With Mutual Funds, (Alpha Books).

To read more columns, please visit the column archive.

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