An attempt to minimize tax liability when given many different financial decisions. There is a wide variety of tax-efficient vehicles, including tax-efficient mutual funds, irrevocable trusts and tax-exempt commercial paper. Choosing the best tax-efficient investment can be a daunting task for those with little knowledge of the different types of products available. The best decision may be to contact a financial professional to determine if there is a way for you to make your investments more tax efficient.
A tax deferred pension plan available to self-employed individuals or unincorporated businesses for retirement purposes. A Keogh plan can be set up as either a defined-benefit or defined-contribution plan, although most plans are defined contribution. Contributions are generally tax deductible up to 25% of annual income with a limit of $47,000 (as of 2007). Keogh plan types include money-purchase plans (used by high-income earners), defined-benefit plans (which have high annual minimums) and profit-sharing plans (which offer annual flexibility based on profits).Also known as an HR(10) plan, Keogh plans can invest in the same set of securities as 401(k)s and IRAs, including stocks, bonds, certificates of deposit and annuities. Keogh plans were established through legislation by Congress in 1962 and were spearheaded by Eugene Keogh. As with other qualified retirement accounts, funds can be accessed as early as 59.5 and withdrawals must begin by age 70.5. Keoghs are known to have more administrative burdens and higher upkeep costs than Simplified Employee Pension (SEP) plans, but the contribution limits are higher, making Keoghs a popular option for many business owners and proprietors.
The reduction of potential income due to taxes. Drag describes the loss in returns owing to taxation, usually on an investment. Tax drag is commonly used when describing the difference between an investment vehicle that is tax-sheltered and one that is not. For many individuals, tax drag can have a significant effect on overall investment performance. Tax-efficient investing techniques are very important for recognizing capital gains, transferring wealth and estate planning. For example, suppose that an individual can invest $1 million in two securities in either Country A (with a 25% withholding tax) or Country B (with a 15% withholding tax). Both securities pay a 2.5% dividend. Security A would return $25,000 minus $6,250 in taxes, for a total of $18,750. Investment B would return $25,000 minus $3,750 in taxes, for a total of $21,250. Therefore, returns would be 1.875% for Security A and 2.125% for Security B, equating to a tax drag of 25 basis points (the difference in returns between the two securities).
A document published by the Internal Revenue Service (IRS) that provides guidance on how taxpayers are to treat income from pensions and annuities using the General Rule. The IRS breaks monthly income from pensions and annuities into two parts: a tax-free part made up of the money that was contributed by the individual, and a taxable part that represents the positive return on the investment. The General Rule is one of two methods used to calculate the tax-free part of a pension or annuity (the other being the Simplified Method, which is covered in IRS Publication 575). Individuals must use the General Rule if they receive income from a non-qualified plan, or plan that does not meet Internal Revenue Code requirements to receive the tax benefits of a qualified plan. IRS Publication 939 does not cover income from life insurance or individual retirement accounts (IRAs), and does not provide specific information on how to use the Simplified Method.
Investment earnings such as interest, dividends or capital gains that accumulate tax free until the investor withdraws and takes possession of them. The most common types of tax-deferred investments include those in individual retirement accounts (IRAs) and deferred annuities. By deferring taxes on the returns of an investment, the investor benefits in two ways. The first benefit is tax-free growth: instead of paying tax on the returns of an investment, tax is paid only at a later date, leaving the investment to grow unhindered. The second benefit of tax deferral is that investments are usually made when a person is earning higher income and is taxed at a higher tax rate. Withdrawals are made from an investment account when a person is earning little or no income and is taxed at a lower rate.
A deduction from gross income that arises due to various types of expenses incurred by a taxpayer. Tax deductions are removed from taxable income (adjusted gross income) and thus lower the overall tax-expense liability. Watch: Tax Deduction Vs. Tax Credit Different regions have different tax codes that allow a variety of expenses to be deducted from taxable income. Tax deductions are often used to entice taxpayers to participate in programs which have a societal benefit. For example, charitable donations and the expenses incurred to make one's home more environmentally friendly can sometimes be deducted from taxable income.
A document published by the Internal Revenue Service (IRS) that provides information on income tax rules for individuals who have retired from federal service. Retirement benefits for federal employees are paid by either the Civil Service Retirement System (CSRS) or the Federal Employee Retirement System (FERS). IRS Publication 721 covers survivor benefits, thrift savings plans, rollovers, federal estate taxes and the Simplified Method for calculating annuity benefits. Part of the benefits paid out is tax free, because they are contributions made by the employee, while the rest of the benefits are considered taxable. The tax-free part is a fixed number; the taxable part is the difference between the full amount and that which is not taxed.
A dollar-for-dollar reduction in the tax payment required from a person. Watch: Tax Deduction Vs. Tax Credit Deductions and exemptions only reduce the amount of your income that is taxable. Tax credits reduce the actual amount of tax owed.
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