Special Report

17 Investments and Strategies to Help Lower Your Taxes

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1. Municipal bonds

Municipal bonds have historically offered the easiest tax-free investment income to investors over time. In general, the interest paid on municipal issues is exempt from federal taxes. To qualify as a “muni” issue, these bonds are issued by individual states, counties, cities, and underlying municipal utility districts (MUD). There are other tax-exempt bonds from U.S. protectorates. The world of muni bonds is perhaps the most commonly thought-of vehicle for tax-free investing.

According to the Municipal Securities Rulemaking Board the size of the U.S. muni issue market is about $3.8 trillion, with about 1 million outstanding muni securities today and roughly $11.6 billion traded in par value every trading day.

Investors should be aware, however, that muni bonds may be taxable in some cases. Some states tax other states’ muni bond issues, and investors have to pay tax on capital gains if they sell a bond prior to maturity for more than they paid for it. Additional tax implications can be seen in bonds purchased at a discount to par value (100.0) and when the Alternative Minimum Tax comes into play.

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2. Annuities

There are many different types of annuities, but basically they are a financial product that an investor buys with the intention of being paid out a fixed stream of payments at some point, whether immediately (immediate annuities) or after some time (deferred annuities).

Critics of annuities claim they have high fees and tend to have low returns. Others prefer the tax implications, mainly that annuities generally allow investments to grow tax-free until the funds are withdrawn. Once withdrawn, however, payouts are taxed at personal income tax rates rather than at the capital gains rate.

The tax implications can be complex and depend on the type of annuity and whether the investor used pre-tax or after-tax income to purchase it. In general and at the most basic level of tax implication, either a portion of the payout amount is tax free or payouts from the principal are tax-free. It is best to check the tax implications of the specific annuity you consider.

The annuity market is huge even if it is not as widely followed by the public. According to the LIMRA Secure Retirement Institute’s fourth quarter 2018 report “U.S. Retail Annuity Sales Survey,” total annuity sales increased 14% from 2017 to $232.1 billion.

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3. Life insurance

Many investors and policy owners might be reluctant to consider life insurance an investment class, but it is. With life insurance, people pay out money every year, and after the insured person passes away the money is given to the named beneficiary (or beneficiaries) in a lump sum. That lump sum receipt is generally is not taxable.

There are two kinds of traditional life insurance — term life insurance and universal, or whole life insurance. Term life insurance is generally far cheaper than whole or universal life insurance because it covers a period of a few years to a few decades rather than indefinitely.

There are also tax advantages in being able to borrow against the cash value of insurance policies tax-free, in a manner that is considered to be more lenient than borrowing against other tax-free or tax-deferred asset classes.

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4. IRA

The Individual Retirement Account (IRA) is one of the most common forms of retirement income strategies. An IRA is generally considered to be a tax-deferred investing strategy for workers who generally do not have access to company-sponsored plans, so it is not technically tax-free.

A traditional IRA allows anyone with wages to contribute money each year that can then grow tax-deferred over time. The Internal Revenue Service recently increased IRA contribution limits for the first time since 2013. The annual contribution limit was increased to $6,000 (from $5,500), and there is an allowance for up to $7,000 per year for those who are 50 and over considering the “catch-up contribution.” As with a traditional IRA and alternative IRA accounts, there are income thresholds for individuals and families that may limit how much, if any amount, can be contributed each year.

According to the Investment Company Institute’s factbook, the total value of IRA accounts in the United States was $9.2 trillion at the end of 2017.

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5. Alternative IRA: SEP

The Simplified Employee Pension Individual Retirement Arrangement, or a SEP IRA, is more commonly referred to as a Self Employed Person IRA. These are for people who are self employed and generally have no employees. The allowance for contribution is generally much higher than in traditional IRAs, but they are also subject to income level phase-outs.