Municipal bonds, also referred to as munis, are securities issued by government-backed entities in your community or in a city that you live or do business in. A corporation, school district, or city may issue these bonds to raise money for projects, which may include anything from road construction to the funding of new firehouses or mass transportation.
Municipal bonds are generally viewed as being lower risk investments, because these entities are backed by the full faith and credit of the cities and towns where they reside.
These bonds also offer attractive tax incentives. Interest earned on municipal bonds is federally tax-free, and in some states it’s state tax-free, too. The most common exception to this tax-free status occurs when people who live in a state with income taxes buy munis from another state. That interest is subject to double taxation.
Aside from tax incentives, the tax-free status of municipal bonds makes them appealing to income-sensitive investors. When you hold munis, you reduce your taxable income.
It’s important to note that there are different types of municipal bonds. Depending on whether you’re looking to purchase bonds issued by a state or a municipality, and also on what type of security it is, the tax implications can vary.
Have a kid in college? I’ll let you in on a little-known secret: You can put money into an account to help pay for college and pay no taxes at all. And it’s true .
529 plans (named for the section of the IRS code that authorized them) launched in 1996 to encourage higher education. They’re operated by states, the federal government, or educational institutions, and they’re run pretty much the same way.
You open an account with a designated custodian, transforming your money into investment options. You pick your investment options (usually a mix of stock and bond mutual funds), and the custodian buys the stocks, bonds, and commodities – so your money is invested without any effort on your part. Once you reach age-18 or 21 (depending on the state), you can use the money for tuition, books, supplies, computers – or anything else related to your education.
The traditional IRA is a regular account, in which you contribute a portion of your paycheck and your employer matches it. Any money you earn by investing is tax-deferred. The money that you withdraw later is fully taxable.
The Roth IRA is also a tax-deferred investment until you withdraw your investment, but the income you earn when you invest is not taxed. So, that’s why it’s called a Roth IRA, or Roth Individual Retirement Account.
You can contribute to a Roth IRA and you don’t have to pay taxes, but you need to meet the income requirements.
If you have kids, you know you have to start setting aside money now to pay for their college education. One option to consider is opening up an UGMA or UTMA account. Both of these are set up in your child’s name, but it is the account owner that makes the investment decisions. If properly administered, the earnings in the account grow tax-free for your child, and when they turn 18, they become the account owner. Then, they will be able to use the money in the account tax-free to pay for whatever they need for college.
A word of advice, though … if you do open an account, be sure to start early enough so that you have time to build up a nice college fund. Depending on how much money you have to invest, you want to make sure your child has enough of an investment to use for college expenses.
Master Limited Partnerships (MLPs)
Master limited partnerships are one of the best investments around, particularly for those who hold passive investments and are seeking to diversify their holdings. Because they are limited partnerships, MLPs offer a tax advantage not available to other investments. The LLP structure keeps taxes on passive income at the source, meaning that you don’t have to pay tax on your entire dividend; you only pay tax on the portion of the dividend that is comparable to the amount that the company pays out to the general partner, such as management fees and administrative expenses.
Investors can hold MLPs by themselves or in their portfolios with other investments, and at first glance, it may seem like their structure is similar to that of real estate investment trusts. Each MLP can vary, but most MLPs are a form of master limited partnership, where a general partner serves as the fund’s manager and commits the equity of the holding company to the MLP, and one or more limited partners invest in many of the MLPs. The general partners are the ones that deal with the day-to-day operations of the partnership, for which they receive money, essentially a management fee, and the limited partners, those who own the holding company, may or may not have an equity interest in a partnership.