When it comes to investing money it’s important to pay attention to the taxes which need to be paid on any and all gains. That’s where tax efficiencies come in. While the term might sound like an obscure form of investment, tax efficiencies simply refers to looking at the kind of taxes that will need to be paid on an investment’s profits, and making sure that the ideal end is kept in mind before any money is actually moved.
An Example Using Savings Accounts
A good example of tax efficiency is using a savings account to plan for retirement. If someone uses a regular savings account then the money put into the account will accrue interest, and tax will need to be paid on that interest. Now say that the same person chooses to use a Roth IRA to save for retirement. The goal is the same; open a savings account to put in money that won’t be taken out until retirement. A Roth IRA though doesn’t have any of the earnings taxed until they’re withdrawn. What’s more, contributions to these accounts are tax deductible, up to a certain amount every year. So not only does one not pay taxes on the interest that the account is building up until later, but contributions ensure that he or she pays lower taxes right now as well.
That is tax efficiency; choosing the method that will result in the least amount of taxes being paid, but which will still get an individual to the goal he or she is aiming for.
Always Consult A Financial Expert
Taking advantage of tax efficiencies requires an intimate knowledge of tax law and all of the options that those laws provide. It’s for that reason that someone who is serious about investing should always contact an expert in investments and tax law before making any major financial decisions.
Sometimes, as with the above example of two different savings accounts, the choice is clear and obvious. Other times though the way might be significantly muddier. If someone is trying to decide whether to invest in real estate or in mutual or hedge funds for instance there will be the question of whether or not the money made from those investments will be taxed the same way. For instance the sale of real estate may be taxed differently than capital gains, and there might be differences across different states. In order to put together the best possible strategy for an investment it’s a good idea to have an expert with this kind of knowledge on the investor’s side.
Is That Legal?
There’s a difference between not paying taxes, and choosing the option that pays the least amount of taxes. The former is illegal and comes with consequences, while the latter is simply smart investing. Working within an established bracket of laws concerning what income is taxed at what rate is just one more aspect of investing that those who want to reach their goals must understand to come out ahead.