As the April tax filing deadline looms, many investors are thinking about the taxes they will have to pay. In the end, though, it’s not what you make that’s important, but what you keep — net of fees, expenses and income tax. Investing in tax-exempt investments can reduce or eliminate your income tax and may provide you with higher net returns than taxable investments.

If you are in a higher tax bracket for federal and/or state tax, a lower tax-exempt yield can provide you with more net income than a higher taxable investment. For example, if you are in the 32 percent federal tax bracket, a 5 percent tax-exempt investment is equivalent to a 7.35 percent taxable investment. In general, the higher your tax bracket, the more you can benefit from tax-efficient investing.

Used properly, with the guidance of your advisory team, tax-exempt investments may provide you with significantly more net return. Managing your tax burden is one of the most valuable benefits you derive from working with our team.

Let’s look at five of the most common financial avenues that enable investors to take advantage of tax-exempt investing.

1. Municipal bonds

Municipal bonds, also known as munis, are debt instruments issued by states and local governments that allow investors to earn interest without having to pay income taxes on the proceeds. Investing in munis can be an effective way for individuals to reduce their overall income tax burden because income is not subject to tax.

Investors can buy the bonds themselves or can buy pooled investments such as mutual funds, unit trusts or exchange-traded funds (ETFs).

Some experts say 2023 looks to be a great year for munis, which is great news because 2022 was a tough year for many  fixed-income asset classes. Yields are now higher for muni bonds than at any other time in the past 15 years. While past performance doesn’t guarantee future results –  dating back to 1989, a down year in the municipal bond market has been followed by at least one year (or several) of positive returns.

2. 529 plans

Another type of tax-exempt investing is a 529 plan, which is a state-sponsored educational savings plan that offers tax benefits when the funds are used for qualified education expenses. Investments in these plans may also offer a deduction on your state tax return.

3. Health savings accounts

Health savings accounts, or HSAs, are the only type of account that offers triple tax benefits. Many medical insurance plans and policies with high deductibles make the insured eligible for contributions to HSAs.

Contributions up to an annual limit are tax-deductible when you make them and are excluded from your gross income when your employer makes them. The account can be invested, and the earnings compound tax-free in the account. Also, distributions from an HSA are tax-free when they are used to pay for or reimburse you for qualified medical expenses that aren’t reimbursed by other sources. Plus, if you incurred unreimbursed medical expenses in earlier years, the HSA can reimburse you for them in the current year, tax-free. Talk to your advisor about moving money from a taxable financial account to an HSA.

4. Employer-sponsored retirement plans

If you work for a company that offers a ROTH  401(k) retirement savings plan, consider maxing out the contributions you make to your account, if you aren’t already doing so, because you can make the contributions on a pretax basis.  Funds grow without tax and all earnings may be tax free if taken after the age of 59 ½.  

5. Long-term capital gains

Investment taxes, called capital gains, come in both long-term and short-term categories. A long-term capital gain is a tax on any investment you’ve held for at least one year, while short-term capital gains are those assessed on investments you’ve held for less than a year.

If you can reach the long-term threshold, your tax treatment will be significantly better. This is because short-term capital gains taxes are levied based on normal income tax brackets, while long-term capital gains have much lower rates of 0 percent, 10 percent, 15 percent, or 20 percent.

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Overall, tax-exempt Investing can be an effective way for individuals to reduce their overall income tax burden. By investing in the products discussed here, you can maximize the amount of money you keep for yourself. These types of investments can also provide a stable stream of income with minimal risk.

Yes, “the tax man cometh,” as the old saying goes, but with the proper planning, you can pay “the tax man” less and keep more for yourself!

We Are Always Here for You

Investing in tax-exempt, or tax advantaged investments can be a great way to minimize your income tax liability and put more money in your pocket. However, it is important to understand the different types of investments available and the associated risks. Also, it’s important to remember that the tax benefits of these investments can vary depending on your particular tax situation. As such, it is always wise to consult with a qualified tax advisor before making any investment decisions.

Our team focuses on helping you achieve your vision in the most tax-efficient manner possible. While we can’t control markets, we often can control the tax implications of portfolio management.

Whether you would like a second opinion on what you are doing or need help designing a new financial plan, please reach out to us, without cost or obligation.

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Randy Carver, CRPC^®, CDFA^®, is the president and founder of Carver Financial Services, Inc., and is also a registered principal with Raymond James Financial Services, Inc. Carver Financial Services, Inc. was established in 1990 with the vision of making people’s lives better — clients, team and community. With this mission, Carver Financial Services has grown to be one of the largest independent financial services offices in the country, managing $2.2 billion in assets for clients globally, as of December 2022. Randy and his team work with individuals who are in financial transition as a result of divorce, retirement or the sale of a business. You may reach Randy directly at randy.carver@raymondjames.com in the office at (440) 974-0808.