Nine tax-friendly ways to save beyond a retirement fund
Retirement saving should be a priority, but it isn't the only way to save. Go beyond retirement saving with these tax-friendly methods.
So you've been taking advantage of your company's 401K plan and have also been placing money in an individual retirement account (IRA). In fact, you've been such a great saver that you've now hit the limit on what you can contribute annually to these tax-advantaged accounts. What to do now?
Well, first off, give yourself a huge pat on the back. You've been saving a ton, and have managed to avoid paying too much tax along the way.
If you still have money you'd like to stash away, but don't want to give too much to the tax man, there are other investment opportunities for you. Take a look at these nine options for super savers like yourself.
1. 529 Plans
If you have children who may one day attend college, it's a great idea to save for their education using a 529 college savings plans. These plans, which are offered by individual states, have a variety of tax benefits. In most cases, you can place money in an investment account and allow it to grow tax free as long as you use the funds to pay for college. You can also often get a tax deduction on contributions.
2. ESA Coverdell Accounts
These work in similar fashion to 529 plans and Roth IRAs, in that money can be invested and then withdrawn tax free. Coverdell accounts have lower account maximums than 529 plans, but often have more investment options and the money can be used for any education expense, including grade school and high school. The maximum annual contribution per beneficiary is $2,000.
3. Municipal Bonds
It's good to have some bonds in your investment portfolio, and here's a way to help out your state, city, or county raise money for its capital expenditures. "Muni" bonds are usually exempt from taxes, so you get to keep more of your investment. These days, you can buy bonds directly, or get a mix of bonds through a bond mutual fund or ETF.
4. Real Estate
When you buy a house or other piece of property, mortgage interest is often tax deductible. If you sell a home, there is often an exclusion on capital gains up to $500,000 if you're a married couple filing jointly.To take advantage of these breaks, the property must be used as a first or second home in most cases. Also, be sure to itemize your deductions when filing your taxes.
The idea behind an annuity is that you make investments, and then the annuity makes payments to you at a later date, or a series of dates. The investments grow tax-deferred, and earnings are taxed at your regular income rate. So if you think you'll be in a lower tax bracket upon retirement, you'll save money. Unlike 401K and IRA plans, there are no contribution limits to annuities.
6. Master Limited Partnerships
More experienced investors may find some great tax savings and solid income from MLPs. An individual can buy shares of an MLP just like a stock. Most MLPs are related to energy production, and allow investors to essentially buy "units" of a gas pipeline, or something similar. Income from MLPs are taxed as "return of capital," so taxes can be deferred. (In essence, you only pay tax when you sell your units.) The taxes on MLPs are complex, but if you are okay with the mountain of paperwork, you may save some money. It's wise to talk to an accountant to get a full understanding of the tax implications before investing in an MLP.
7. Whole Life Insurance
I am not a big fan of whole life insurance as an investment, but there can be some tax advantages to having a policy. It's also an okay option for high earners who have maxed out other accounts. Whole life policies pay a death benefit, which is not usually taxed. Many policies also offer tax-free dividends. If you're interested in whole life insurance, make sure you're capable of paying the annual premiums. And do your homework to make sure that the dividends and growth potential outweigh many common downsides, such as high fees and commissions.
8. Index Funds
If you maxed out the contributions to your retirement plans, any additional investments you want to make will probably have to go into a taxable brokerage account. But that doesn't mean you can't find ways to keep your tax burden relatively low. Index funds are mutual funds that track a specific index, such as the S&P 500. Generally speaking, index fund managers don't have to do a lot of buying and selling, so they aren't passing on a lot of capital gains to you. You'll still have to pay tax when you cash out, so they aren't really "tax advantaged" in the classic sense. But you'll be saving money along the way.
Exchange-traded funds are like mutual funds, in that they usually track a specific index or market sector. But they are more tax efficient than mutual funds, because investors only pay capital gains when they sell the ETF. You won't avoid tax altogether unless the ETF is part of a retirement plan, but your liability will be as low as possible.
This article first appeared at Wise Bread.
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