Dealing With Higher Taxes in 2010

Its a bright Monday morning in Americas capital city. While going about your business, you may be wondering about what 2010 has in store for your money. Well, here are some thoughts:

Local governments are going to raise taxes and fees. Governments at all levels are running large deficits. Typical efforts to close deficit gaps involve some combination of increased taxes or user fees. In particular, the massive size of the Federal deficit indicates your income taxes are likely to increase.

So what does all this mean for you?

A) Pick the right account. If you are at all able to, sock away your money using ROTH 401ks, 401ks or ROTH IRAs. The rules vary, but in tax deferred accounts earnings on your investments tend to grow assessment free. This is especially the case for stocks and bonds, but you can hold gold and real estate in these types of accounts also.

B) Consider municipal bonds. Investors don't have to pay federal taxes on dividends from muni bond funds because these funds invest only in relevant government paper which is exempt from taxation. While the rates these funds pay are typically pretty modest, the after tax returns can look good compared with taxable funds.

As a quick note here - some beginning investors buy muni bonds in their retirement accounts. You don't need to do this because municipal bond interest is tax free already. A broker I know made this mistake. Her client dropped her for it.

C) Keep taxes in perspective. People go to great lengths to avoid taxes. Rich people found philanthropic organizations and ship their money abroad, common people work under the table or under report their income. You are probably pretty honest when it comes your income taxes, but the point here is that you should keep things in perspective. If you are too obsessed with taxes, it can distort how you make decisions.

For example, a lot of people didn't want to sell their tech stocks at the height of the 2001 boom. They didn't want to sell because they didn't want to cough up the 20% tax on their capital gains. When the tech bubble burst, a lot of these folks were left with nothing. The bottom line here is that you shouldn't let taxes distort your investment decision making.