Tax Pros Reveal 3 Investment Moves That Can Push You into a Higher Tax Bracket
Written by
Sarah Li Cain
Edited by
Angela Corry
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While there are more traditional reasons to be bumped into a higher tax bracket, such as a raise, certain investment decisions can also increase taxable income and push you into a higher tax bracket.
This often happens unintentionally as investors grow their wealth.
To help explain what investments can bump you into a higher tax bracket, GOBankingRates spoke to two certified financial planners and found out what investors should watch out for.
1. Holding Mutual Funds in Taxable Accounts
Investors in certain accounts don’t always realize how little control they have over capital gains distributions, like those who invest in mutual funds.
“People who invest in these funds need to be aware that they have little control over the distribution of capital gains,” he says. “Ones in non-retirement accounts will both increase your overall income and could lead you into a higher tax bracket than you have been in the past.”
How it works is that mutual funds distribute both short-term and long-term capital gains. Short term gains can increase your taxable income for the year. The type and amount of distributions can vary widely depending on the mutual fund’s activity, so one year could look very different from the next.
Sprung ways that these capital gains are usually distributed towards the end of the year, which could mean that the wrong timing can push you into a higher tax bracket if you don’t watch how you manage your investments.
“I have seen many instances where investors make a sizable investment into a fund only to receive a large capital gains distribution a week after owning it,” he said.
If this happens, you may owe taxes on gains before you’ve even owned the fund for a full year. That added income from the short term capital gains can unexpectedly bump you into a higher bracket.
2. Failing to Review Your Tax Return Early
Sometimes a higher tax bracketing might not be a specific move you make, but a lack of foresight.
Nick Gertsema, CFP®, ChFC®, RICP®, AIF® says that not understanding what your taxes have looked like in previous years could hurt you in the future.
“The earlier in the year you can do tax planning, the sooner you can implement some tax strategies and hopefully help eliminate surprises come tax time,” he says.
For example, doing a basic tax analysis can help you see the bigger picture of your past tax situation.
“If you see high short term capital gains or dividend income, a better move may be as simple as changing what investments you have in which accounts,” Gertsema says.
3. Switching From Traditional to Roth 401(k) Contributions
If you change the type of retirement contributions you make, it can change your taxable income and push you into a higher tax bracket.
“Making a simple change such as updating the contributions to your 401(k) from a traditional to Roth,may have an unintended effect on your overall tax bracket,” Sprung says.
Contributions to traditional 401(k) contributions reduce taxable income today, and Roth contributions do not. If you decide to do so, make sure you plan and assess to see how it could change your tax situation.
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