Non-taxable investments are investments where it is not required to pay taxes on the profits that the investments generate. These types of investments are mostly helpful for people in higher tax brackets. A tax bracket is the amount of tax someone is charged at a certain income. These investments help reduce your tax bill while still providing income. Below, we explore various non-taxable investment options, explaining how each works and their potential benefits.
Municipal Bonds
Local, state, or municipal governments issue municipal bonds. Bonds are like loans that people can give to the government that provides income through interest as well as the principal amount. The interest income from these bonds is generally exempt from federal income tax. If you invest in bonds issued by your home state, the interest might also be exempt from state and local taxes. These bonds are a popular choice for tax-conscious investors seeking steady, tax-free income.
Series EE Bonds
The U.S. government issues Series EE Bonds. The interest earned on these bonds can be exempt from federal income tax if you use them for educational purposes and meet other IRS requirements. They are a safe investment option, backed by the full faith and credit of the U.S. government. Series EE Bonds are guaranteed to double the money after 20 years, and the government will add money to fulfill this, though the money can be left for up to 30 years.
Series I Savings Bonds
Series I Savings Bonds, also issued by the U.S. government, provide tax exemption for interest earned if used for educational expenses, under similar conditions to Series EE bonds. These bonds offer a combination of a fixed interest rate and an inflation-adjusted rate, protecting your investment from inflation.
Roth IRA
A Roth IRA is a retirement account that can only be withdrawn once the holder is at least 59.5 years old and has had the account for at least 5 years. It allows contributions with after-tax dollars, meaning you don’t get a tax deduction when you contribute. However, withdrawals in retirement, including earnings, are tax-free. This makes Roth IRAs a good option for those who expect to be in a higher tax bracket in retirement.
Roth 401(k)
Similar to a Roth IRA, a Roth 401(k) involves making contributions with after-tax dollars. Withdrawals during retirement, including earnings, are tax-free. Roth 401(k)s are typically offered by employers and combine the benefits of a Roth IRA with the higher contribution limits of a 401(k).
Traditional IRA
Contributions to a Traditional IRA may be tax-deductible, reducing your taxable income for the year you contribute. Taxes on earnings are deferred until you make withdrawals, which are then taxed as ordinary income. This allows your investment to grow tax-deferred, potentially providing more growth over time.
401(k) Plans
401(k) plans let the person put in their pre-tax money. The money they put in isn’t taxed until they withdraw it from the plan, then it is taxed as normal income. Many employers offer matching contributions, which can significantly boost your retirement savings.
403(b) Plans
403(b) plans are available to employees of public schools and certain non-profits. Like 401(k) plans, contributions are pre-tax and taxes on earnings are deferred until withdrawal. These plans often have similar benefits to 401(k)s, including employer matching and tax-deferred growth.
457 Plans
457 plans are available to state and local public employees, and some non-profits. Contributions are pre-tax, and earnings grow tax-deferred until withdrawals, which are taxed as ordinary income. These plans can offer additional retirement savings opportunities for public sector employees.
Health Savings Accounts (HSAs)
HSAs allow contributions to be made pre-tax, reducing your taxable income. Earnings grow tax-free, and withdrawals for qualified medical expenses are also tax-free. HSAs are a powerful tool for saving on healthcare costs, both now and in retirement.
529 College Savings Plans
Contributions to 529 plans grow tax-free, and withdrawals used for qualified education expenses, including tuition, room, and board, are tax-free. These plans are an excellent way to save for a child’s or grandchild’s education while enjoying tax benefits.
Coverdell Education Savings Accounts (ESAs)
Similar to 529 plans, contributions to ESAs are not tax-deductible, but earnings grow tax-free and withdrawals for educational expenses are tax-free. ESAs offer more flexibility in how the funds can be used.
Variable Annuities
Variable annuities allow contributions to grow tax-deferred, and taxes are only paid when you make withdrawals, which are then taxed as ordinary income. They offer a way to invest for retirement while deferring taxes on investment gains.
Non-taxable investments can play a crucial role in your financial strategy, helping to reduce your tax burden while still providing income and growth opportunities. Whether you’re saving for retirement, education, or healthcare, understanding these options can help you make informed decisions and maximize your after-tax earnings.
