Making Tax-Free Investments
Whenever a good investment comes along, the first two things that enter the mind of any good investor are "what a great deal!" followed inevitably by "how much would I be paying in taxes?"
The prospect of not paying any taxes on investments has always been a wise choice for the world savvy investor, but what about the rest of us?
Following are some ways to save taxes while investing:
- Buying municipal bonds. You do not have to report any interest you make off these as part of your income on any city, state, or federal taxes. The reason for starting these bonds was to get more people to invest in the government. Essentially, you are allowing the use of your money by the government. There had to be a good incentive for people to choose to invest in municipal bonds, so the government made these bonds tax-free. You do not have to pay taxes on any income you derive from these bonds. This is especially profitable for those people who are in the higher tax bracket.
- Purchase savings bonds. When you invest in savings bonds, you can use the special U.S. Savings Bond exclusion, under which all or part of the income that you make off the saving bond is exempt. The following are some requirements for taking advantage of this exclusion:
- You paid off your college tuition by cashing in your bonds.
- You are single and/or filing separately
- The maximum exclusion is for joint returns that don't go over $79,650 and $53,100 for all other returns. The exclusion doesn't exist for people who have a joint income of over $109,650 or single income that exceeds $80,000.
- The bond must be in your name.
Investing with a Roth IRA. Although you do not get any deductions for the year in which you purchase a Roth, all withdrawals that you make, principal or income, thereafter is tax-free.
A little note for the folks who collect social security: it may be a good idea to invest first in a tax-deferred investment, then a tax-free investment. The reasoning behind this is that if a person who collects social security makes too much income off of a tax-free investment, the IRS will tax their social security receipts. However, the IRS does not count the income made from a tax-deferred investment until funds are actually withdrawn.