Becoming familiar with the basics of financial literacy - budgeting, investing, and personal finance - helps most Americans create plans to achieve their financial goals. However, financial literacy goes beyond the basics. In fact, a 2020 survey found that the majority of surveyors lost approximately $1600 due to lack of understanding - in the U.S that’s a loss of over 415 billion dollars. So it begs the question, how do investors stop leaving money on the table?
If you’ve already laid the foundation with the basics, the next big opportunity is within your tax liabilities. Tax liabilities are simply the taxes you will pay to the government though our focus is taxes that occur while investing. More specifically, we take time to review taxation on various account types, the “gold standard” for withdrawing funds, and how/when penalties are triggered.
To understand different tax liabilities, the first thing we review is account type. Each investment account has distinct tax liabilities which are in the form of short and long term capital gains, ordinary income, and tax-free. The amount taxed will depend on the account type, investment time frame, and income, as well as some other factors. Below are some common account types and typical taxation methods.
*When funds are used for non-medical expenses under age 65 and 20% additional penalty.
**When taken as a loan.
***Non-qualified and 10% penalty.
As you can see, the chart is not as straightforward as it seems. There are exceptions and instances where you can find yourself with higher tax liabilities for failure to understand the restrictions. There are even cases where accounts can lose their tax advantaged status. Each situation is unique and there isn’t a “one size fits all” solution. If you need some assistance or want to learn more, simply schedule a meeting using the link below.
Be on the lookout for Part 2, where we’ll break down taxation rates and review consequences. In the final part 3 of our series, we’ll wrap up on when to take money out of each account to minimize your tax liability.
If you fail to plan, you plan to fail.