Choose tax-efficient investments
When a job doesn't provide income, investments often do -- in the form of interest, capital gains and dividends. The returns on different types of investments are treated differently at tax time. Qualified dividends and capital gains are taxed at a lower rate than ordinary income. The interest paid on bonds is generally taxed as income -- except when it's not, such as in the case of municipal bonds. Most muni bonds are tax-exempt at the federal level, giving investors tax-free income.
"It's all about monitoring adjusted gross income, so the most obvious solution to reduce the tax burden is tax-free bonds or tax-free investments," says Scott Berger, CPA, principal at Kaufman, Rossin & Co. in Boca Raton, Fla.
Investments held in a taxable account, rather than a tax-deferred or tax-free retirement account, require strict attention. Even if it's a stock mutual fund and not an income-producing investment, you can still get hit with a tax bill.
"You have the ability to hold it in tax-efficient investments such as low turnover funds, or an ETF that may have low turnover and low capital gains," says Herman. Turnover refers to the amount of trading managers do within the fund. Unless the fund is managed in a tax-efficient way, investors can end up paying for the funds' capital gains which reduces their overall return over time.