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For thousands of years, the fascination with precious metals has been a staple of human civilization. Metals like gold and silver acted as currency in the form of coins, and the rarest of metals ended up as status symbols in the form of jewelry and decorations. Not that long ago, most of the world’s economies relied on the Gold Standard as the foundation of their currency value.
While those days are gone, gold remains relevant today. It is one of the most commonly traded commodities in the world and serves as an alternative form of investment for many. The price of gold skyrocketed in the early 2000s, attracting many potential investors with annual returns easily outperforming the stock market. The trend flipped in the 2010s, and most of the investors during that period lost money by investing in gold.
Still, gold remains an attractive option for many investors looking to diversify their investment portfolios. When it comes to investments, annual returns are just a part of the story. What most investors crave is to maximize their after-tax returns. This puts taxation at the center of every investment decision you will make.
This blog will cover the most common gold investment types, how is gold taxed in an IRA, and how you can lower the gold tax rate.
Types of Gold Investments
Traditionally, if you wanted to invest in gold, you would purchase either coins or gold bars and hang on to them until it is time to sell them at a profit. Nowadays, various gold investment vehicles are available to potential investors.
- Golden coins and bullion are the traditional way of investing in gold. An investor can purchase official golden coins or bullion from a registered broker and either store the investments at home, keep them in a safe deposit box in a bank, or pay an annual storage fee to the broker to hang onto them.
- Physical gold exchange-traded funds (ETFs) combine the investments in physical gold with a stock market principle. Investors purchase shares of an ETF. Each share is equivalent to a real-world weight of physical gold (usually one-tenth of an ounce).
- Closed-end funds (CEFs) share many similarities with ETFs, with a significant difference in the structure of the fund. CEFs are, in essence, trusts.
- Non-physical gold investment vehicles also are available, including gold mining stocks, gold mutual funds, and gold mining ETFs. They provide an entrance into gold investing, but the majority of investing is not in physical gold. The returns of those investments directly relate to the price of gold, global production, borrowing cost, and trading activity.
Regardless of which type of investment you choose, you should know they all come with potential benefits and risks. An investor needs to research all investment options and make an informed decision on which option will yield the highest return at an acceptable risk.
The Cost of Investing in Gold
Before we get into details about gold taxation, it is important to say a few words about which other costs are present when you invest in gold. Great annual returns quickly disappear once dozens of fees and expenses pile up. Keeping a check on the cost of investing in gold will improve your bottom line and minimize the risk of a loss.
- Gold storage is one of the main costs that investors face when they invest in physical gold. Storing the gold in your home in a safe is the cheapest option in the long run but brings an increased risk that most people are not comfortable with. Alternative options include renting a safe deposit box in a bank with an annual fee or paying the registered gold brokers to store your gold for a fee.
- Gold transactions are a significant cost that investors should consider. Depending on your choice of a broker, the fees charged for buying and selling gold will differ. Investing in gold funds typically includes an annual fee for managing your portfolio and trading. It is essential to calculate your gold investments’ actual return rate after the deduction of the transaction costs.
- Taxes remain the largest expense that gold investors will face once they decide to cash in on their gold IRAs. We will cover the taxation in more detail later in the blog.
- Insurance remains an important cost, especially for those who decide to store gold on their own. Protecting your investment from theft or the bankruptcy of a brokerage or a bank should be a priority. The last thing you want is to lose your hard-earned money without insurance.
Gold and Taxes
You are thinking about investing in gold. You have to decide which type of gold investment will yield substantial returns without producing a huge tax bill. To better understand gold taxation, it is essential to look at tax treatment and gold classification.
The IRS considers gold investments as investments in collectibles. Practically, by investing in gold, you are receiving the same treatment as those investing in art, baseball cards, or comic books. That comes with its own set of challenges, including a somewhat unfavorable tax rate.
There are two main scenarios when it comes to those who invest in gold. In the first scenario, an investor purchases gold, holds onto it for less than a year, and sells it. These transactions have the same tax treatment as ordinary income or short-term capital gains (STCGs). The second scenario includes an investor purchasing gold and hanging onto it for more than a year before selling it. Unfortunately, as a collectible, gold does not have the status of a long-term capital gain (LTCG). This means that gains from those investments are taxed as ordinary income, but with a 28% maximum tax rate cap.
This is a massive tax hit for most gold investors, and for years investors sought alternative vehicles for investing in gold to lower the tax bills and improve the after-tax returns on their investments. Currently, the most popular and affordable option is to invest in gold through an individual retirement account (IRA). In the next section, we will cover the details of gold IRAs and how you can improve your after-tax returns by choosing to invest in one.
Taxation of Gold IRAs
IRAs burst onto the scene in 1974, offering individuals a long-term investment vehicle for retirement. The major advantage of IRAs was that investments made in the IRA are taxable upon withdrawal by the investor. It is an excellent opportunity for investors to delay the payment of taxes and lower their capital gains for that year.
In the beginning, IRAs did not allow collectibles as a form of investment. This began to change in 1986 when the IRS allowed investment in US gold and silver coins. The IRS expanded that in 1998 to include bullion with the purity of at least 99.5%. The major shift came in 2007 when the IRS announced that IRA investments in gold ETFs are not considered investments in collectibles. Investors started taking advantage of this option, and it remains popular today.
There are certain restrictions that IRS places on investors who use IRAs to invest in gold. The most significant one is that investors must not have possession of any physical gold they are investing in. The gold has to be in storage at a registered intermediary during the investment. Intermediaries charge investors an annual fee for administration and storage. Regardless of those restrictions, gold IRAs remain a viable investment vehicle for gold.
If you decide to open an IRA for investing in gold, these are the main factors you should keep in mind:
- Traditional IRAs allow most types of gold investments and offer higher after-tax returns than Roth IRAs or brokers.
- Taxes on gains from gold IRA investments are due once the investor cashes out. The IRS taxes those gains the same way as ordinary income – using a marginal tax rate.
- Gold IRAs are subject to additional taxes and fees. The most common fee is the 10 percent early withdrawal penalty for those who cash in an IRA before 60.
- A collectible tax rate of 28% does not apply to IRA investments in gold. The marginal tax rate applies to those gains. Unfortunately, that also means that those in the high-income brackets might pay more than 28% in taxes.
- The amount you will pay in taxes depends on your income bracket. The amount withdrawn from the IRA is added to your gross income and taxed accordingly.
- If your investments generate losses, you will not be able to deduct those losses on your tax filing.
- You must start taking distributions from the IRA by the age of 70 1/2.
Have you considered adding gold to your investment portfolio? Gold IRAs offer an excellent combination of investment flexibility and better after-tax returns than other gold investment vehicles. If you would like to know more about your gold IRA options, check out our site. At Oxford Gold Group, we provide resources and information to potential investors who would like to diversify their portfolios and invest in gold. Finding a gold IRA partner has never been easier.