How to Maximize the Benefits of Tax-Free Investing

Daniel Penzing
Written by
Last update:

Fund Your 401(k) Beyond Your Employer Match

It’s important to maximize your 401(k) before you try to contribute outside of it. That means that you should take advantage of any employer match. Many employers offer a 50% match on your first 6% of pay or something similar.

Depending on your salary, that can be a very significant contribution that you can’t afford to pass up. You still have the advantage of tax-deferred growth, and the sooner that you start, it will have a bigger impact on your overall net worth than a 401(k) with a larger employer match.

When you’ve maxed out the match, focus on increasing the amount that you contribute as much as possible. Paying off high-interest debt is a good starting point, as it’s paying interest to the bank instead of yourself. After you’ve done that, you can start adding to your retirement accounts.

The other benefit to a 401(k) is that you generally have more investment options. Many employers also offer a large selection of mutual funds, target date funds, and even individual stocks as investment options.

Max Your IRA Savings Every Year

If you haven’t already, you should consider opening an Individual Retirement Account (IRA) with a custodian such as Fidelity. While many investors save for retirement in workplace-based plans such as 401(k)s, IRAs can offer some big advantages.

Take Advantage of an HSA If You Can

A high-deductible health plan (HDHP) and a health savings account (HSA) provide a lot of benefits.

Once you’ve made the decision to invest, you want to ensure you take full advantage of everything that’s available to you. And one of the benefits of being a medical saver is the tax-advantaged HSA investment accounts.

Some debt management tools can help you get your debt under control faster. But it can be practically impossible to pay off a huge loan in a short period of time.

To give your money the best chance of growing, put it in a low-cost investment. Remember, investment success is based on two factors: time and returns. For the best returns, invest your money in the stock market.

Growth stocks are risky, but they also tend to have higher returns. And because they’re risky, you can’t afford to make one costly mistake or your account will be gone.

The suggestion that your bank is offering a CD with a high yield is great.

So, whether you work out of your home or own a business that requires a lot of travel, you can rest easy knowing that your money is not at risk.

Consider a 529 for Education Expenses

There are certain reasons why it is good for your child to get an education in your state of residence … but, on the other hand, there are quite a few reasons why it is better to go to college in a different state.

Of course, no one is saying that instead of helping your kid pay for the cost of college in your college town, you should drop him off in Shiprock, NM, but there are quite a few great reasons that if your child could gain admission to a college somewhere else, it might be worth looking into.

For example, the federal government has set up something called the 529 Plan, in which you can use your state income tax return to sidestep the income tax consequences that go along with college money. In many states, like New York, for example, there is a tax on money earned by children in a 529 Plan, whereas in some states like Delaware, there are no such taxes. If you know for sure that your child is going to go to college out-of-state, it pays to look at a plan from that state rather than yours.

So whether your child has a bright future at Princeton or an exciting career at the Chartwells food services building in your hometown, you should go ahead and look into the options for saving money on those college bills.

Two Words: Muni Bonds

For those who have ever had to file taxes, you know just how complex and complicated it can be. For many, there are no shortage of headaches that come along with filing taxes. But to make matters worse, it can lead to some hefty fees and penalties if you’re not careful.

This is why many people who have high-interest savings accounts would prefer simply to dump the money in a high-interest savings account.

But we already established that there is an inherent benefit in tax-free investing. But, this benefit is lost if you’re simply parking the money in a bank account. With that in mind, there is another tax-saving option that can make your money grow even faster …

But, before we dive in a discuss the delicious world of muni bonds, it’s important to understand your financial situation, and your risk tolerance.

What is a Muni Bond? A municipal bond, or muni bond, is a bond that is issued by a municipality. This is something that every single state or city has the ability to do, which is why it’s known as a “muni.” By definition, it is a type of government bond, and this is something that is subject to its own set of specific rules.

Consider a Charitable Donation of Stock

Before you do any shopping in your IRA or 401(k), consider how you can optimize your tax deductions by making a donation to charity. It’s a great way to get the most out of your money.

If your IRA or 401(k) is-full, you can always shop in your IRA and list the donation to a charity as a deduction. Then, when you distribute the funds from your account – the traditional IRA or 401(k) is divided into several taxable distributions – list the actual amount of the donation as a deduction.

If your IRA or 401(k) is invested in growth or stocks, you can still choose to donate those funds and then pull an immediate tax deduction, even though that money may be subject to a big, future tax. If you do this, use fair market value to determine the amount of the deduction and make sure you keep track of the donation on the tax form. Another great thing about this strategy is that, by doing it before you take a distribution of all the account money, you free up capital to invest elsewhere.

Taxes Saved Are Dollars in Your Bank Account

If you have been working and saving your money for years, we would be surprised if it didn’t become a bit of a burden to come into the end of the month and have to pay out a lot of money to the federal government.

How do we get out of this bind? The answer is not through working harder or saving more, but through saving smarter … tax-free.

The initial reaction to the idea of tax-free investing may seem a bit far-fetched, but there are numerous ways that someone can invest their money and save on taxes at the same time.

First and foremost, most of the mutual funds, retirement accounts, and brokerage accounts you might already be investing through are already tax-sheltered in one way or another. These retirement accounts are tax deferred, and hold their principle tax-free. Therefore, if you have been putting away your money in these types of accounts, then you have already been enjoying the benefits of tax-free investing.

What if you do not already have a brokerage account? Do not panic. We can still get you started on the path to tax-free investing. One of the best ways to get started, is through a Roth IRA.