17 Investments and Strategies to Help Lower Your Taxes

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.

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prefer the tax implications, mainly that annuities generally allow investments to grow tax-free until the funds are withdrawn. Once withdrawn, however, payouts are taxed at personal income tax rates rather than at the capital gains rate.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.

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.

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.

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.

The Roth IRA is considered to be a hybrid retirement and saving vehicle. This retirement account is to be funded using after-tax income dollars. The saver is effectively paying the taxes up front rather than in the future, and that allows even the withdrawals from Roth IRA accounts to be tax-free when the rules are followed properly. Figuring out the benefit of a Roth IRA versus traditional IRA accounts generally depend on a person’s tax bracket today versus the expected tax bracket in his or her retirement years. Generally a Roth IRA makes more sense for investors who expect their tax rate to be higher during retirement than their current rate. Again, there are phase-out limits as well above certain taxable income levels.

If you are an employee of a company, chances are high these days that if you have a retirement plan it is a 401(k) plan. These defined contribution plans allow eligible employees to contribute up to $19,000 per year, up from $18,500 in previous years, using pre-tax dollars. Similar to an IRA, assets in a 401(k) grow on a tax-deferred basis and are taxed when the person withdraws the funds.

What is so attractive about a 401(k) plan is that employers often match an employees contributions, either dollar-for-dollar or a portion of each dollar, up to a certain percentage of their income. That continued contribution and matching dollars get invested over time and enjoys the advantages of compound returns.

There are some risks and pitfalls to 401(k) plans. Many employees choose to liquidate their funds when they leave one company to go to another or if they are terminated. This early withdrawal gets taxed, and the IRS imposes a 10% penalty on funds that are withdrawn before eligibility.

Master limited partnerships (MLPs) are a type of limited partnerships that are publicly, therefore provide the tax advantages of limited partnerships and the liquidity of publicly traded securities. Because most MLPs are in the oil and gas business, they often move along with the broader economy and the ups and downs of the oil and gas markets.

The tax advantages comes from the fact that the MLP’s distributions are not considered dividends. The breakdown varies from partnership to partnership, and there dozens of public MLPs trading today, with each distribution a combination of income and a return of capital. The income portion is taxed, but the return of capital is not taxed and acts to lower an investors cost basis over time. Any capital gains made in MLPs are subject to normal capital gains taxes, and these come with K-1s rather than dividend forms for your tax filings.

A 529 plan allows a family to set aside funds for a child’s college education. The IRS does not generally allow these to be used with pre-tax dollars, but the funds grow tax-free if they are withdrawn for specified and qualified education expenses. These funds can also be used as a family trust of sorts because any leftover funds that pass down to the child in the adult years grow without being taxed until the child’s retirement. There may also be gift tax consequences if there is more than $14,000 contributed to the 529 in a single year, and there are lifetime contribution limits per account. The tax reform has also allowed a more general use of 529 plans for other educational purposes long before college years.

The Uniform Gifts to Minors Act (UGMA) and the Uniform Transfers to Minors Act (UTMA) allow for minors to own financial securities. Usually parents open such accounts on behalf of their children, add funds, and are the custodians of the accounts. The tax benefit of these accounts is that often a portion of the investment can be considered a tax-free gift. Another advantage is that child’s own tax rate can apply to these accounts rather than the parents’ rate.

While there are no restrictions on investment classes in a UGMA account, the funds are allowed to be spent on anything (even non-educational expenses) for the benefit of the child. Generally, donors to the UGMA/UTMA accounts can claim up to $13,000 per year, or $26,000 for couples filing jointly, as a tax-free gift. The downside here is a loss of control over the fund when the child reaches the age of maturity — then the account is theirs to spend however they see fit.

Giving away stock that has appreciated is one simple form of donation that comes with a serious tax advantages for investors. The investor, now donor, is not taxed on the capital gains that have accumulated in the donated stock. Further, the entire donation amount — the market value of the donation (to a charitable or religious organization-optional) on the day it is made — is tax deductible.

Investors who buy and sell stocks or mutual funds over time often use losses to offset capital gains come tax time. Many investors might have made large gains from the sale of Boeing, Microsoft, Amazon or other stocks in 2018. If they also sold shares of GE at a loss, for example, the loss can help offset some of those gains. Investors need to be aware of the Wash Sale Rule, which prevents investors from artificially realize losses. Also, if an investor has more capital losses than gains, they are allowed to use up to $3,000 each year to offset ordinary income, and if the loss is even greater, it can be carried forward into future years.

Most investors just assume that Treasury notes and Treasury bonds are taxable. They are taxable under federal income tax purposes, but states generally do not get to tax those interest payments made by the U.S. Treasury to Joe Public. It is part of the reciprocal tax agreement whereby the IRS does not tax interest made on municipal bonds. Just keep in mind that if you have a realized capital gain by selling a Treasury for more than you paid for it, that part may get taxed by your state if the state levies income and capital gains taxes.

The IRS does not exactly want the entire nation to be day-trading stocks and assets. The current difference between short-term and long-term gains is defined by one year — anything longer than one year is considered long term. If you sell a stock for a gain 360 days after you bought it, it is a short-term gain and is generally taxed at your income tax bracket. If you sell a stock, mutual fund, or asset 366 days or 10 years after purchasing it, the gain is taxed, usually at a much lower capital gains rate.

While your tax bracket may be determined by your income from your primary work and paychecks, starting a side business comes with certain tax advantages. While the side business will hopefully be successful and add to your income, you are allowed to deduct certain business expenses from you gross income, which may lower your total tax burden. It is important to follow IRS guidelines when it comes to using health care expenses, utility and internet bills, home office costs, and gasoline and/or mileage expenses as your deductions. Entrepreneurs also need to consider that if a business starts losing money year after year, the IRS may view it as a hobby rather than a business entity. And having excessive deductions tied to a side business that continually negate your taxes will probably result in an audit by the IRS and/or your state.

A Health Savings Account (HSA) is usually meant for people who have a high-deductible health insurance plan. Contributing into an HSA can reduce your taxes because the contributions are in pre-tax dollars. Not everyone with a high-deductible plan can qualify for an HSA, and there are contribution limits as well that have changed over time. In 2018, the maximum contribution amount was $3,450 for individuals and $6,900 for a family — and that went up to $3,450 and $7,000, respectively, for the 2019 tax year. This money can then grow without paying taxes on the gains. Generally, HSA funds are used for qualified medical expenses. There are expected minimum annual withdrawals that are expected to be used for medical expenses.

Many expenses can qualify for tax credits rather than just being deductible. While a deduction lowers your taxable income, a tax credit reduces your actual tax bill by the amount of the credit. They are meant to help middle- and low-income households. The higher the income, the less likely a person or family would qualify for tax credits. And depending on the income and status, you might qualify for just a portion. The IRS lists several credits for individuals and families, and it is worth checking your qualification for these, especially for low- to moderate-income earners. Among the credits are the earned income tax credits, which also applied to self-employed individuals; the child and dependents care credits, which helps cover costs of daycare, for example; and credits for education and retirement saving among others.