Tax-Efficient Investing: Key to Making the Most of Your Money

OCTOBER 15, 2021


Knowing how much you are paying in taxes with regards to your investments can be just as important as your rate of return. By ensuring part of your portfolio is tax-efficient now can help you save when it comes time to retire. 

When it comes to your investments—if you’re like most people—you probably focus on the return rates. That’s great, but if you want to keep more of those returns in your pocket rather than Uncle Sam’s, you need to minimize how much you pay in taxes.

One way of doing so is by making tax-efficient investments. Also referred to as tax-advantaged, tax-deferred or tax-exempt, tax-efficient investments include individual retirement accounts (IRAs) and 401(k) plans, both of which give you an upfront tax break by allowing you to deduct your contributions in the tax year in which you make them.

While your annual contributions to these investments are capped—$6,000 to IRAs ($7,000 if you’re 50 or older) and $19,500 to 401(k)s ($26,000 if you’re 50 or older) for 2021—they grow, tax-deferred, until you withdraw them in retirement, at which point you’re likely to be in a lower tax bracket and thus pay less tax.

While advantageous tax-wise, these accounts do have downsides in the form of withdrawal rules and penalties. As a result, you may instead opt for or also have a brokerage or other taxable account that comes with no limits on how much you can invest and that allows you to sell your investments and/or withdraw your money at any time for any reason.

As long as you’ve held the investments for more than a year before selling them, you’ll pay only the long-term capital gains rate1 on any gains you have. That rate ranges from 0 to 20 percent depending on your tax bracket2.

For investments held less than a year, you will pay short-term capital gains. These gains, considered ordinary income, will be taxed at higher rates: from 10 to 37 percent depending on your income.

 

Two advantages of being tax-efficient

Making your taxable accounts tax-efficient can benefit you in two important ways:

  • Advantage #1: No required minimum distributions. Traditional IRAs and 401(k) plans3 require you to begin withdrawing money at age 72. However, with brokerage and other taxable accounts, there is no age at which you must begin to withdraw the money you’ve saved and/or invested; that money can remain invested—and potentially increase in value—indefinitely.
  •  Advantage #2: Potential tax savings for your beneficiaries. When your beneficiaries eventually sell the investments they inherit from you, they will be taxed on their value at the time of your death, not at the price you paid when you purchased them. This means you not only avoid paying capital gains on the growth of these investments, so too will your beneficiaries. This can be an especially big advantage if the value of the investments has increased significantly over time.
 
Annuities are tax-efficient, too

One additional way to be tax-efficient with your investments is via annuities. Annuities are long-term, tax-deferred vehicles designed especially for retirement. Although deposits into annuities are not tax-deductible, the interest you earn is tax-deferred; you won’t have to pay taxes on it until you begin making withdrawals.*

That’s good news as this tax-deferral period can have a dramatic effect on the accumulation and withdrawal amounts of your investments. Use this calculator to see how.

There are three main types of annuities, each of which can provide tax-deferred growth:

  • Fixed annuities preserve your principal because your money is not invested in the market. Instead, fixed annuities pay you a guaranteed fixed interest rate that adds interest to your account the entire time you own the annuity. What’s more, fixed annuities take advantage of the power of tax-deferral: you keep more of what you earn, giving you more money that can continue to grow in value.
  • Fixed index annuities are long-term, tax-deferred vehicles also designed especially for retirement. They combine the advantages of fixed annuities with the opportunity to participate in a portion of the growth that may be realized by  a market index such as the S&P 500 or the Dow Jones Industrial Average.
  • Variable annuities allow you to spread your wealth across a wide range of investment options which may help grow your assets, tax-deferred. However, unlike fixed and fixed index annuities, variable annuities involve investment risk and may lose value. 
 

So, whether you are growing your assets in preparation for retirement or to leave a legacy for those you love, it’s important to explore the many tax-efficient investments available to you, including annuities. To learn more about the potential benefits of annuities, start your journey here.

1. Nerdwallet.com, "2020-2021 Capitol Gains Tax Rates - and How to Calculate Your Bill," Tina Orem, September 10, 2021.

2. Nerdwallet.com, "2020-2021 Tax Bracket and Federal Income Rates," Tina Orems, May 13, 2021.

3. Nerdwallet.com, "IRA vs. 401(k): How to Choose," Dayana Yochim, Andrea Coombes, March 17, 2021.

*Earnings are taxable as ordinary income when distributed. Individuals may be subject to a 10% additional tax for withdrawals before age 59½ unless an exception to the tax is met.Tax deferral offers no additional value if an annuity is used to fund a qualified plan, such as a 401(k) or IRA, and may be found at a lower cost in other investment products. It also may not be available if the annuity is owned by a “legal entity” such as a corporation or certain types of trusts.

All indexes are unmanaged and not available for direct investment.  The payment of dividends is not reflected in the index return.

This material was prepared to support the promotion and marketing of Jackson annuities. Jackson, its distributors, and their respective representatives do not provide tax, accounting, or legal advice. Any tax statements contained herein were not intended or written to be used and cannot be used for the purpose of avoiding U.S. federal, state, or local tax penalties. Tax laws are complicated and subject to change. Tax results may depend on each taxpayer’s individual set of facts and circumstances. You should rely on your own independent advisors as to any tax, accounting, or legal statements made herein.

Annuities are issued by Jackson National Life Insurance Company (Home Office: Lansing, Michigan) and in New York, annuities are issued by Jackson National Life Insurance Company of New York (Home Office: Purchase, New York). Variable products are distributed by Jackson National Life Distributors LLC, member FINRA. May not be available in all states and state variations may apply. These products have limitations and restrictions. Contact the Company for more information.

Guarantees are backed by the claims-paying ability of Jackson National Life Insurance Company or Jackson National Life Insurance Company of New York and do not apply to the principal amount or investment performance of a variable annuity’s separate account or its underlying investments. They are not backed by the broker/dealer from which this annuity contract is purchased, by the insurance agency from which this annuity contract is purchased or any affiliates of those entities, and none makes any representations or guarantees regarding the claims-paying ability of Jackson National Life Insurance Company or Jackson National Life Insurance Company of New York.

The latest maturity date or income date allowed under an annuity contract is age 95, which is the required age to annuitize or take a lump sum. Please see the prospectus for important information regarding the annuitization of a variable annuity contract.

Jackson® is the marketing name for Jackson Financial Inc., Jackson National Life Insurance Company®, and Jackson National Life Insurance Company of New York®.

Tom Hurley, Phil Wright, and Ashley Feltner are affiliated with Jackson. All other authors are not affiliated with Jackson.