Taxes are a part of life. The average federal refund check for the 2013 tax year,
was $2,755.Just over 110 million returns qualified for a federal refund for the
2013 tax year. Put another way, the federal government wrote checks totaling
nearly $302 billion for tax payers.
More than likely, if you are interested in tax strategies, you didn’t get any
money back from the federal government for 2013. In fact, there is a high
probability you may have sent the Treasury Department a check.
It’s not necessary to have a comprehensive understanding of the tax code”and the
thousands of pages of federal tax regulations that back them up. But to manage
the impact of taxes, it’s critical to understand certain principles. A study by
Morningstar, Inc., showed that during the 85-year period ended in 2011, investors
who did not manage investments in a tax-sensitive manner lost between one and two
percentage points of their annual returns to taxes. That means that a
hypothetical stock return of 9.8% shrank to 7.7% after taxes.
Morningstar’s research was compiled to illustrate the potential impact of taxes
on investment performance. Past performance does not guarantee future results.
This is a hypothetical example used for illustrative purposes only. It is not
representative of any specific investment or combination of investments. Stocks
are represented by the Standard & Poor’s 500 Composite Index (total return), an
unmanaged index that is generally considered representative of the U.S. stock
market. Individuals cannot invest directly in an index.
Morningstar calculated the federal income tax by using the historical marginal
and capital gains tax rates for a single taxpayer earning $110,000 in 2010
dollars every year. Annual income was adjusted each year using the Consumer Price
Index (CPI), which is considered representative of overall U.S. prices at the
consumer level. CPI adjustments were used to adjust the income level for each
year. Income was taxed at the appropriate federal tax rate when it was taken.
When realized, capital gains were calculated using the appropriate capital gains
rate. For stock prices, the holding period for capital gains tax calculation is
assumed to be five years. No state taxes were included in the calculation. Stock
prices will fluctuate in value over time.
Tax-favored investing involves both tax-exempt investments and tax-deferred
investments. Tax-exempt investments, which include such vehicles as municipal
bonds and certain money market funds, offer a tool where your money has the
potential to grow exempt from federal taxes. Municipal bonds are free of federal
income tax and may be free of state and local income taxes for investors who live
in the area where the bond was issued. Tax-deferred investments, on which taxes
are postponed until you withdraw your money, include qualified retirement plans,
such as traditional IRAs and employer-sponsored plans, as well as insurance
products like annuities and sometimes life insurance. Money held in money market
funds is not insured or guaranteed by the Federal Deposit Insurance Corporation
or any other government agency. Money market funds are investment funds that seek
to preserve the value of your investment at $1.00 a share. However, it is
possible to lose money by investing in a money market fund.