How to Pay Less Tax on Interest Income
Maybe you can’t stash all your income investments in tax deferred accounts. But there is a way you can protect against paying too much tax on them. Here’s how.
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Full Transcript below:
00;00;00;00 - 00;00;25;10
Unknown
Welcome back to 30 Minute Money, the podcast that delivers action oriented smart money ideas and bite sized pieces. I'm Scott Fitzgerald at Roc Vox Recording and Production in our Bushnell's Basin studio, with Steve Wershing from Focused Wealth Advisors and dropping my phone. But that's okay. You're throwing your cooking around. That's what we call. See you again. Live. Recorded.
00;00;25;10 - 00;00;52;06
Unknown
Live. Distorted things. Exactly. Good to see you, Steve. And, we're going to we're going to talk about two of your favorite, subjects. Taxes and interest. Yes. And how you can pay the least on the other one. Yeah. Yeah. Yeah. So what we're going to talk about today is minimizing the tax you pay on interest. And the reason that we're talking about this is as interest rates have gone up when they went up dramatically, of course, you know, in the last couple of years they went up significantly.
00;00;52;08 - 00;01;20;08
Unknown
And this was brought home to me today as I was reviewing a tax return with a client. their balances had not changed very much. They have very, very steady situation. But last year they paid about they paid tax on about $2,000 worth of interest. And this year they paid taxes on $11,000 worth of interest. Now, only difference is that interest rate rates went up so much that now they're collecting a whole bunch more interest, which is great.
00;01;20;10 - 00;01;40;20
Unknown
But we really want to be sensitive to how much that's driving our tax burden. Because, you know, these people are near the top of a bracket. And one of those could put them over into a higher bracket. So, so you know, earning more interest is good. Yay. pay more tax is bad. So we want more more of more of one and less of the other.
00;01;40;20 - 00;02;01;18
Unknown
So that's what we're going to talk about today. So the way that we the where we start with that is just be thoughtful about what you're putting in, the different kinds of accounts you have. And that's that's a discipline that we call strategic asset allocation. So all strategic asset allocation means is if you have let's just say you you know, you're the recommendation is you have a 6040 portfolio.
00;02;01;18 - 00;02;19;06
Unknown
I mean there's we never do it quite that simply. But just for the sake of illustration, let's say you need a 6040 portfolio. That does not mean that every account you have should be 6040, because that means that all of your taxable accounts will be 40% income generating things. That doesn't make any sense. All it's doing is generating a bunch of interest.
00;02;19;06 - 00;02;39;13
Unknown
It's going to show up on your tax return at the end of the year. So if your overall portfolio is 6040, great. Let's see how much of that 40 we can stick in the retirement accounts where it's not going to show up on your return at the end of the year and put the, you know, put the growth oriented stuff in the taxable accounts where it's not going to do any damage, right, where it's not going to generate a whole lot of stuff.
00;02;39;13 - 00;03;07;27
Unknown
That's, that's, that's taxable, even even those growth oriented things that generate income. Usually it will be in the form of dividends. Or if you're buying and selling things, it'll be in the form of capital gains. Those are taxed at a lower rate. Typically then interest would be which is taxed like salary. And so strategic asset location just means put the bonds and the retirement accounts, put the stocks in the taxable accounts and that's a good start on it.
00;03;07;27 - 00;03;28;04
Unknown
Now you may not be able to do that entirely. Like it may not be appropriate to to make your entire taxable account stock. That might be that might put too much stuff in stocks. So there's other things that we can do in those taxable accounts to help prevent things from to bad to, to keep from generating taxable interest.
00;03;28;12 - 00;03;48;16
Unknown
One of the, one of the easiest things to do in the first place, that a lot of people go in their minds is to buy municipal bonds or municipal bond funds, or tax free bond funds. Those will generate interest, but typically they are not taxable. They're not taxable on a federal level. And here in New York State, if you buy New York state bonds, they're not taxable on a state level either.
00;03;48;18 - 00;04;10;01
Unknown
But there's a trade off there. And what we really want to keep our eye on is the after tax yield. So, if a if a municipal bond is paying 3% and you don't have to pay any tax on it, then we are after tax return is 3%. Great. If you're in, you know, you might compare that to a corporate bond that is fully taxable.
00;04;10;01 - 00;04;37;27
Unknown
But the corporate bond might be paying 5% or 5.5%. If you're in a really high tax bracket and you have a corporate bond, well, you might get a lot of that stuff taxed away. So the municipal the municipal bond that pays 3% might be really attractive to you. But, you know, if you're in a 12% bracket or a 22% bracket, even after tax, you might be better off with the corporate bond because not enough is going to be taxed away to make the municipal bond competitive.
00;04;37;27 - 00;04;55;09
Unknown
So there are so one of the things you've got to do is, is to take a look at where you are in the tax brackets, take a look at what taxable investments would yield, take a look at what tax free investments would yield, and just subtract the tax burden that you would have on the taxable kinds of bonds.
00;04;55;16 - 00;05;14;12
Unknown
And just do the do a comparison of the after tax yields to make sure you're still getting a good deal. It may not like I said, it may. We have a lot of retired clients that are in very low tax brackets, and they're much better off with corporate bonds because they're in a such a low tax bracket. They're still making way more after tax than they would be if they had a municipal bond.
00;05;14;15 - 00;05;35;02
Unknown
But there are other things as well. So one of the things that gets sold a lot is annuities. Because annuities, are tax deferred investments with no contribution limit. IRAs have contribution limits for one can have contribution limits. Annuities do not. You can put as much as you want in an annuity. And as it grows it's tax deferred.
00;05;35;10 - 00;06;06;13
Unknown
But it's always a but especially with annuities there's always a but the problem with that is that when you go to pull money out of an annuity, it comes out profit first. And all of those profits are taxed like income. They're tax like salary. So even if what you had in the annuity was generated, capital gains, when you pull it out of the annuity you pay, you pay tax on 100% of it until you've gotten all the way down to your original investment.
00;06;06;16 - 00;06;33;10
Unknown
And it's all taxed like salary. So I again, I'll say it again, annuities are a precision tool in the right situation. They can be great, but they just get recommended and way more situations than that. So, there's one other thing that that we found a while ago that's really kind of interesting. And it's an exchange traded fund that is built to mimic the one year treasury, but it doesn't have any yield.
00;06;33;15 - 00;06;55;14
Unknown
So if you buy a Treasury security, you'll get interest payments on it. and you have to pay tax on that just like income. But there is there are now vehicles like this exchange traded fund that we found that, it uses a sophisticated strategy internally and it and it, so it links itself to US treasuries, but it doesn't generate a yield.
00;06;55;14 - 00;07;13;12
Unknown
So if US treasuries have a 5% yield this year you get 5%. You have to pay tax on that. This this other kind of instrument that's built to mimic it, it will go up 5%. But unless you sell it you don't know any tax on it. So you got the 5% that you would have gotten from the Treasury security.
00;07;13;15 - 00;07;39;09
Unknown
But you know, but you don't. But it doesn't show up on your 1040 at the end of the year. Now, this is not something that's appropriate for everybody. But if you have a portion of your taxable portfolio that that you want invested relatively securely, it's a way of doing it in a way and in a way that's not going to be generating additional taxes for you.
00;07;39;11 - 00;08;14;05
Unknown
Your retirement is at risk, not from the stock market, not from inflation. Taxes are putting your retirement at risk. I'm certified financial planner Steve and I specialize in helping people create low tax retirement. Unmanaged taxes can take 30, 40, even 50% of your retirement income. Learn how to defend yourself against excess taxation. Our complimentary webinar will cover all the principles you need to know to protect your money for you and your family, and keep it away from the government.
00;08;14;07 - 00;08;35;19
Unknown
This free webinar will cover how taxes are different in retirement. The taxes you pay in retirement that you don't have to pay during your working life. How to move tax savings into a tax free environment. The widows tax, the Secure act, the Secure act 2.0 and what they mean to you. The webinar is free, but you have to register to save your spot.
00;08;35;19 - 00;09;05;05
Unknown
So go to Focused Wealth advisors.com/webinars and find out more and sign up right there. Even if you're not planning to retire for the next 5 or 10 years, this information will be critical for you. The longer you have to put the strategies into effect, the more you can accomplish. That's focused wealth advisors.com/webinars to find out more and to sign up today.
00;09;05;08 - 00;09;23;03
Unknown
All right. So what's your 30 minute action item 30 minute action item. Take a look at your last tax return and how much taxable interested you have to claim on it. Last year. Thanks again for joining us on 30 Minute Money. Steve can be found at Focused Wealth advisors.com. You can find the website wherever you get your podcasts.
00;09;23;03 - 00;09;50;19
Unknown
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