Tax-Efficient Fund: What It Is, How It Works, Example (2024)

FAQs

What are examples of tax efficiency? ›

The fund typically invests in stocks of large-cap and mid-cap companies and also may invest a significant portion of its assets in technology companies. The fund's goal is to generate competitive pre-tax performance and outperform on an after-tax basis over a full market cycle.

As long as you have taxable income, you can contribute to a tax-advantaged IRA and save toward retirement. Like 401(k) plans, different types of IRAs provide different tax benefits. Traditional IRAs are tax-deferred. Contributions are deductible and earnings are untaxed until you withdraw your money.

What Is Tax-Advantaged? The term tax-advantaged refers to any type of investment, financial account, or savings plan that is either exempt from taxation, tax-deferred, or that offers other types of tax benefits. Examples of tax-advantaged investments are municipal bonds, partnerships, UITs, and annuities.

An efficient tax system raises revenue while minimizing unintended consequences, and an equitable tax system imposes obligations on taxpayers in proportion to their resources.

Your effective tax rate is your total tax divided by your taxable income. In our example, your tax bill is $11,017 and your taxable income is $70,000. Your effective tax rate would be $11,017 divided by $70,000, or 15.7%.

Index funds—whether mutual funds or ETFs (exchange-traded funds)—are naturally tax-efficient for a couple of reasons: Because index funds simply replicate the holdings of an index, they don't trade in and out of securities as often as an active fund would.

Choosing investments with built-in tax efficiencies, such as index funds—including certain mutual funds and ETFs (exchange-traded funds)—is one way to minimize the tax drag on your returns. ETFs may offer an additional tax advantage. The way their transactions settle allows them to avoid triggering some capital gains.

Top Tax-Efficient Mutual Funds for Bond Exposure

Fidelity's muni funds have long rated among Morningstar's favorites, including Fidelity Intermediate Municipal Income, Fidelity Municipal Income, and Fidelity Tax-Free Bond. T. Rowe Price's municipal funds also earn high ratings, including T.

You can withdraw funds from your investing account at any time without tax penalty. Any investment gains and dividends in your investing account may be subject to taxes.

What is a tax-advantaged account example? ›

Types of Tax-Advantaged Accounts

Tax-deferred accounts: These include 401(k) and traditional IRAs and offer tax savings when you contribute to the account. You're then on the hook when you take money out. Tax-exempt accounts: These include so-called Roth 401(k)s and IRAs as well as 529s.

The tax advantages of a 401(k) begin with the fact that you make contributions on a pre-tax basis. That means you can deduct your contributions in the year you make them, which lowers your taxable income for the year. Note that this benefit applies to traditional 401(k) plans, not Roth 401(k) plans.

Some tax benefits are related to the ability to pay taxes. For example, the child tax credit and the earned income tax credit (EITC) recognize the cost of raising a family. Other tax benefits, including mortgage interest and charitable donation deductions, are incentives designed to further social policy goals.

An S corporation, sometimes called an S corp, is a special type of corporation that's designed to avoid the double taxation drawback of regular C corps. S corps allow profits, and some losses, to be passed through directly to owners' personal income without ever being subject to corporate tax rates.

For example, if you earn $1,000 in a state with a flat income tax rate of 10%, $100 in income taxes should be withheld from your paycheck when you earn that income. If, a week later, you take $100 from your remaining earnings to purchase a new smartwatch in a jurisdiction with a 5% sales tax.

One type of tax that does not create a large excess burden is the lump-sum tax. A lump-sum tax is a fixed tax that must be paid by everyone and the amount a person is taxed remains constant regardless of income or owned assets. It does not create excess burden because these taxes do not alter economic decisions.

Efficient - more revenue can be raised at a lower cost through withholding of income tax at source, allowing for a stable revenue stream to the government. Simple - if designed properly (with fewer income tax brackets), it can be easy to understand and comply with.

A good way to maximize tax efficiency is to put your investments in the right account. In general, investments that lose less of their returns to taxes are better suited for taxable accounts. Conversely, investments that tend to lose more of their returns to taxes are good candidates for tax-advantaged accounts.

The inefficiency of Taxation refers to a situation when the tax imposition in the economy is not able to fulfill its basic purpose.