Taxes might not be the most thrilling part of investing, but when you’re dealing with gains (or losses), understanding how they impact your wallet is essential. Taxes and automated investing can be a complex pair, but in this guide, we’re here to demystify how they work together so you can make the most of every dollar. From capital gains to tax-advantaged accounts, here’s everything you need to know about navigating taxes in the world of automated investing.

1. How Automated Investing Impacts Your Taxes

With automated investing, your investments are managed according to specific strategies without manual input, which often means more transactions than a traditional “buy and hold” approach. This automated trading can generate various taxable events that impact your year-end tax bill. Here’s what you need to know:

• Capital Gains Taxes: Automated investing often involves frequent buying and selling, which can create short-term or long-term capital gains. Short-term gains (for assets held under a year) are usually taxed at a higher rate than long-term gains, so keep an eye on the holding period of your assets.

• Taxable vs. Non-Taxable Accounts: If your automated investing is happening within a taxable brokerage account, you’ll face taxes on gains each year. But if you’re using a tax-advantaged account like a Roth IRA, your gains grow tax-free, which means you won’t pay any taxes as your money grows.

2. Capital Gains and Losses: What You Need to Know

Automated investing can amplify capital gains and losses. Here’s how they work:

• Short-Term Capital Gains are taxed at your regular income tax rate, so they can be pretty steep depending on your tax bracket. Automated investments that involve frequent trades are more likely to trigger these.

• Long-Term Capital Gains apply to assets held over a year and are typically taxed at lower rates—15% for most people, or 0% if you’re in a lower-income bracket.

• Capital Losses can actually work in your favor. If your automated strategy has a bad year, you can use these losses to offset gains in other areas, potentially reducing your tax liability.

For savvy investors, understanding capital gains and losses is like learning the cheat codes to the tax system. Pro tip: Capital losses can offset gains dollar-for-dollar and even reduce up to $3,000 in ordinary income per year if you have more losses than gains!

3. Using Tax-Loss Harvesting to Your Advantage

Automated platforms often have tax-loss harvesting built in, which is a big perk. Tax-loss harvesting is a strategy where your portfolio manager sells off investments that are performing poorly to “harvest” a loss. This loss can offset gains, lowering your overall taxable income.

• How It Works: Let’s say you invested in a stock that dropped in value. Through tax-loss harvesting, your automated platform sells that stock at a loss, which reduces your taxable gains. The system then reinvests in a similar stock to keep your portfolio balanced.

Not only does this reduce your taxes, but it also means you’re buying back into the market at a lower price. Tax-loss harvesting is a powerful tool to reduce taxes, especially during volatile market years when losses may naturally occur.

4. Watch Out for the Wash-Sale Rule

The wash-sale rule is a tricky IRS regulation that can surprise investors using tax-loss harvesting. It essentially disallows a tax deduction if you sell a security at a loss and then buy it back (or something similar) within 30 days.

For automated investors, this is where things can get complicated since some algorithms might automatically rebuy assets. To stay compliant, some platforms have safeguards to avoid wash sales, but it’s still essential to check.

Quick Tip: Avoid repurchasing the same asset within 30 days if you plan to claim the loss on your taxes.

5. How Dividends and Interest Affect Your Taxes

Dividends and interest income from automated investing also come with tax implications:

• Qualified Dividends are taxed at the same rate as long-term capital gains, which means a lower rate for most investors.

• Non-Qualified Dividends and Interest Income are taxed at your regular income rate, which could be as high as 37% if you’re in the top tax bracket.

Your automated investments may pay out dividends, so knowing the type (qualified vs. non-qualified) is essential. Many automated platforms provide year-end summaries to make reporting this income straightforward.

6. The Benefits of Investing in Tax-Advantaged Accounts

Investing within a tax-advantaged account (like an IRA or Roth IRA) is the golden ticket to keep more of what you earn. Since gains in these accounts grow tax-free, automated investing strategies can buy and sell as much as they want without creating a tax burden.

• Traditional IRA/401(k): Investments grow tax-deferred, and you pay taxes upon withdrawal, ideally in retirement when your tax rate may be lower.

• Roth IRA: Investments grow tax-free, and qualified withdrawals are entirely tax-free, so all that compounding is yours to keep.

Choosing a tax-advantaged account for your automated investments is like having a tax shield around your portfolio, allowing for frequent trades without immediate tax consequences.

7. Why Automated Investing Strategies Might Be the Way to Go

While managing the tax implications of investing can be a handful, automated investing platforms take care of much of the heavy lifting. With built-in tax strategies like tax-loss harvesting and optimized rebalancing, these platforms are ideal for investors looking to grow their wealth without the headaches of tax season.

The Bottom Line

Understanding how taxes impact automated investing can save you a significant amount in the long run. The good news? Automated platforms are increasingly tax-aware, implementing smart tax strategies that maximize your after-tax returns. By combining tax-smart practices like tax-loss harvesting, understanding capital gains rules, and considering tax-advantaged accounts, you can keep more of what you earn and reduce that year-end tax burden.

Remember, taxes don’t have to be a dreaded part of investing if you plan ahead and leverage the right tools! Just make sure you’re aware of any potential tax implications and, if needed, consult a tax professional for personalized advice.

Disclaimer: The information presented is for educational purposes only and not an offer or solicitation for any specific investments. Investments involve risk and are not guaranteed. Consult with a financial adviser before making any investment decisions. Past performance does not guarantee future results.