The rarity and beauty of gold have attracted investors for centuries, leading to the jewelry industry accounting for almost half of the global demand for gold. Additionally, gold bars and coins, known as gold bullion, represent 32% of the demand. Investing in gold bullion in 2004 would have yielded a pretax annualized return of over 12% over the following 10 years.
Although there are risks involved, this return does come with its own challenges. In recent years, the price of gold has seen a significant decline, resulting in a pretax loss of over 14% annually for a gold investment made in 2012. However, it is important to note that the instability of commodities, including gold, is just one aspect of the situation.
For tax purposes, physical gold investments are classified as collectibles, and the tax treatment for gains on these investments depends on how long they are held. If the collectibles are held for one year or less, the gains are taxed as ordinary income, just like short-term capital gains (STCGs). If the collectibles are held for more than one year, the gains are still taxed as ordinary income, but with a maximum tax rate of 28% (Sec. 1(h)(4)). This 28% maximum tax rate for collectibles is significantly higher than the 15% long-term capital gain (LTCG) rate that applies to most other assets and taxpayers. However, high-income taxpayers have a maximum LTCG rate of 20% in tax years beginning after Dec. 31, 2012.
The annual pretax return of gold has been 12% over the last ten years. However, on an after-tax basis, this return decreases to less than 10%. If gold had been classified as a capital asset and taxed at a 15% capital gains rate, the after-tax return would have been close to 11%. Additionally, losses on collectibles are first used to reduce capital gains, worsening the situation. Therefore, it is crucial to have a tax-efficient vehicle for gold investments in order to maximize after-tax returns. One possibility is to utilize an individual retirement account (IRA). Although gold was initially not allowed in IRAs, it is now possible to purchase most common forms of gold investments within an IRA, except for Krugerrands (South African gold coins).
The following is a brief overview of the history of investing in gold and the usual methods of investment.
For many years, gold ownership was restricted, even though it is currently a popular investment. In 1933, President Franklin D. Roosevelt made it against the law to possess a large quantity of gold coins and bullion through Executive Order 6102. The purpose of this restriction was to decrease gold hoarding, which was believed to hinder economic growth under the monetary gold standard. It remained in effect for over 40 years until it was removed in 1975. At first, there were only a limited number of investment choices, such as a few gold bars and coins.
Gold coins as well as bullion bars
When considering investing in gold, gold coins and bullion bars are often the first things that come to mind. One advantage of coins is that the reputation of the country that issues them instills confidence in their purity and weight. While the fineness of gold coins can differ among countries, they typically contain one troy ounce of gold, equivalent to about 1.1 U.S. ounces. The spot price, which is the cost of one troy ounce of gold on major world commodities markets, is an important factor to consider. The difference between the purchase and selling prices is the spread, or markup, that sellers make as profit. Additionally, there are costs associated with storing physical gold. For most gold investors, a small safe deposit box is sufficient and costs between $30 to $70 annually. Brokers charge an annual fee ranging from 0.5% to 1% of the value, which usually includes insurance against theft or loss.
Gold bars can serve as an option instead of gold coins. Various entities issue gold bars, with Credit Suisse being the most well-known among them. The markup on gold bars is usually lower compared to country-specific gold coins, although both are considered collectibles for tax purposes.
How a gold IRA can lower your taxes
Gold IRAs can assist in reducing the amount of taxes you will owe on your investment funds in various ways.
Tax-deferred or tax-free growth
When selecting the type of gold IRA, you can choose whether your money is taxed at the time of contribution or at the time of withdrawal. Opting for the appropriate type can effectively reduce your overall tax liability and retain a higher portion of your funds.
Traditional gold IRAs allow you to fund your account with pre-tax dollars, enabling you to avoid paying taxes on your contributions. Instead, the funds are taxed when you decide to withdraw them based on your income level at that time. If your income is expected to be lower during retirement, choosing a traditional gold IRA could result in decreased tax payments.
Roth gold IRAs involve the use of after-tax funds, resulting in taxed contributions at the time of making them. However, withdrawals are exempted from taxes. Therefore, if you anticipate a decrease in your income upon retirement compared to your current income, a Roth gold IRA could potentially decrease your tax obligations.
If you are self-employed or a small-business owner, you have the option to open a SEP gold IRA that functions similarly to a traditional IRA but allows for larger contributions.
Tax deductions
By contributing to traditional gold IRAs, you can potentially deduct taxes in the year of contribution. This deduction lowers your taxable income for that particular year, consequently reducing the amount you will be required to pay on your tax bill.
Tax-free rollovers
If you possess a regular traditional IRA, Roth IRA, or 401(k), you have the option to convert it into a gold IRA through a gold IRA rollover. By directly transferring the funds from your current retirement account provider to your new gold IRA, you can avoid subjecting the rolled-over funds to taxes.
If you decide to perform an indirect rollover, which involves receiving the funds from your previous account and depositing them into the new account, you must ensure that this deposit is completed within 60 days from when you receive the funds. Failure to do so will result in the funds being subject to taxation as distributions.
Lower taxes for your heirs
Although it may not provide a direct advantage for yourself, it is important to consider that a gold IRA can also assist your beneficiaries in reducing their tax burden.
If beneficiaries receive a Roth gold IRA, it is unlikely that they will have to pay taxes on the distributions. In contrast, if they receive a traditional gold IRA, the distributions will be taxed at their income tax rate. However, if the estate is subject to estate tax, the beneficiaries will be given a deduction for the estate taxes that were previously paid from the estate.
The bottom line
Investors seeking to safeguard their retirement savings from market volatility, inflation, and economic uncertainty may find investing in a gold IRA to be a wise decision. Additionally, this option offers potential tax advantages, allowing individuals to retain a larger portion of their earnings and rely on it during their retirement years.
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