There's not much you can do to shave the taxes on your salary. But when it comes to the taxes you pay on savings and investments, there's a lot you can do to protect your profits from the tax man.
It makes sense to try: After all, it's not what you make, but what you get to keep that counts. Tax-advantaged products and strategies can help you keep more, as long as you don't go overboard -- giving up return and paying too much just to save on taxes. That's called letting the tail wag the dog and it's not a good idea.
Stay focused on the bottom line, then, and look at these six solid ways to save money on taxes.
-- Roth IRAs. There's no immediate benefit to putting money into a Roth IRA, but in the long term, they are golden. Money pulled out in retirement is not taxed. An early start allows you to compound more money in earnings than you contribute, and pulling it out tax-free allows for great planning opportunities in retirement. You can still put $4,000 in a Roth IRA for 2007 ($5,000 if you're at least 50) and $5,000 for 2008 ($6,000 for those 50 and older). Folks who earn more than $99,000 (single) and $156,000 (joint filers) make too much to contribute to a Roth IRA. They can consider plowing money into a traditional, nondeductible IRA so that in 2010, as current tax law allows, they can move that money over into a Roth IRA.
-- Municipal bonds and muni-bond funds. Bonds are not offering the best returns these days, but to the extent your portfolio has a bond component, it's worth looking at munis. They are floated by local and state governments for community projects, and are typically exempt from federal and state taxes (if you live in the state that issues the bonds).
To decide if a muni bond or fund is worth buying, use this formula: Express your marginal tax bracket as a decimal (.33, for example), and subtract it from 1. Take the remainder (.67) and divide it into the bond's yield. (If a bond is yielding 5 percent, dividing that by .67 gives you 7.46 percent.) That's the equivalent yield you'd have to get on a taxable bond to make it comparable on an after-tax basis.
-- Individual stocks. The purpose of investing in individual stocks, of course, is to see them go up so that you earn money when you sell them. If it works according to plan, you'll have to pay 15 percent capital gains tax on the long-term profits you reap by selling a stock. That's instead of the 25 percent or higher rate you're likely to pay on ordinary income, so they're already a good tax deal. But individual stocks come with a tax bonus: If you find yourself losing money, instead of making it, you can sell your shares and use that loss to reduce the other taxes you owe. There's no better cost-efficient way to cut investment taxes than to carefully manage an individual stock portfolio so that you're always reaping your losses.
-- Tax-managed mutual funds. These funds do the loss-harvesting for you, but they usually charge more in fees for the extra service. That means they are a good choice for folks who make a lot -- so much that they are in high income brackets, have maxed out their 401(k) contributions and can't contribute to a Roth IRA. Even then, keep an eye on the expenses involved to be in the fund.
-- Exchange traded funds and index funds. Both of these types of funds tend to keep investment taxes low, because they infrequently realize gains by trading within their portfolios. Both are typically very inexpensive to buy.
Exchange traded funds offer one additional bonus: You can buy them and sell them during the market's open hours and get a pretty good idea of what your price will be. That allows you to harvest losing positions in them, too.
-- That 401(k). It's at the bottom of the list, only because you've heard it so many times before. It's hard to beat the advantages of a decent 401(k), especially if your company is matching your tax-deductible contributions. To maximize its tax-saving properties (and if you're investing elsewhere in staid, low-tax products), fill it with the kinds of investments that you'd otherwise pay high taxes on: real estate and bond funds and aggressive, high turnover stock funds.