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Say you have a retirement goal of $1 million and reach it by investing a stock. If you want to rebalance and move this money to something safer, say bonds, will this exchange cost you capital gains + state income tax? Meaning once you reach $1 million, you haven't actually met it after taxes are deducted.

Is there any way to reduce taxes, assuming the investment is held outside a 401k or IRA and used for retirement purposes?

  • Good question, but I seriously doubt it. The Government is gonna get their money. – JohnFx Jan 3 '14 at 0:11
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There are ways to mitigate, but since you're not protected by a tax-deferred/advantaged account, the realized income will be taxed. But you can do any of the followings to reduce the burden:

  1. Prefer selling either short positions that are at loss or long positions that are at gain.

  2. Do not invest in stocks, but rather in index funds that do the rebalancing for you without (significant) tax impact on you.

  3. If you are rebalancing portfolio that includes assets that are not stocks (real-estate, mainly) consider performing 1031 exchanges instead of plain sale and re-purchase.

  4. Maximize your IRA contributions, even if non-deductible, and convert them to Roth IRA. Hold your more volatile investments and individual stocks there - you will not be taxed when rebalancing.

  5. Maximize your 401K, HSA, SEP-IRA and any other tax-advantaged account you may be eligible for.

  6. On some accounts you'll pay taxes when withdrawing, on others - you won't. For example - Roth IRA/401k accounts are not taxed at all when withdrawing qualified distributions, while traditional IRA/401k are taxed as ordinary income. During the "low income" years, consider converting portions of traditional accounts to Roth.

  • Thanks for this. So to take one example scenario, if a man who lives in California, is trying to save 1 mil for retirement, after taxes he actually would need to save around 1.4m? Is that correct? – Jonathan Winters Jan 3 '14 at 3:16
  • @AaronDunn that depends on the rate of withdrawal and your tax rate then, but that would be somewhere in the ballpark, for taxable accounts. However, depending on your investments, you may save 1mil, but withdraw dividends/rents/fixed income, which while still being taxed - won't reduce your principle. – littleadv Jan 3 '14 at 4:02

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