While that may be true, savvy investors know tax-free investments are out there, if you know where to find them. Not only that, but you don't have to be part of the Wall Street elite to access them. In fact, they should be a part of your investing strategy.
We asked four of our top contributors to discuss these tax-free investments, and they came up with ones that almost every investor should be able to use at some point. Chances are, you can start benefiting from at least one of these immediately.
Selena Maranjian:The fact that many states and cities need cash to fund projects is good news for those looking for tax-free investments. That's because a common cash-raising solution is to issue municipal bonds, and such bonds' interest is free from federal taxation. It can even be tax free at the state or city level if you buy bonds from the city or state in which you live.
Municipal bonds aren't quite as safe as Treasury bonds and debt issued by our federal government -- consider the case of Detroit, which declared bankruptcy. But most cities and states don't fail financially, and some municipal bonds are even backed by insurance.
You can protect your municipal bond investments to a great degree by spreading your money between many of them, diversifying away some of the risk. A municipal-bond-focused mutual fund -- or, better still, an exchange-traded fund, or ETF, is perfect for that, offering instant diversification within a single investment and the ability to sell shares easily and on your schedule. Two contenders are theMarket Vectors Long Municipal ETFand thePowerShares National AMT-Free Municipal Bond ETF. There are many more, including some that focus on particular states, which can deliver a double tax benefit.
Best of all, investing in municipal bonds not only offers tax-free income, but it also helps you build a balanced, diversified portfolio of stocks and bonds. That's not so critical when you're young, but as you approach and enter retirement, it can make sense to have a significant and growing portion of your assets parked in bonds.
: Sometimes the best way to make a tax-free investment is with the intention of gifting stock to charity or someone you love.
As an example, let's assume you invested $5,000 in a stock, which in six months turned into $10,000. There are a number of options here for you as the investor. You could lock in your $5,000 gain and pay the capital gains tax based on your marginal tax bracket. You could also cross your fingers and hang on to your investment for the full year in hopes of paying a lower long-term capital gains tax rate of 0%, 15%, or 20%.
Your other option is to gift your stock to your favorite charity or beneficiary. If you gift stock in the short term (after holding the stock in question for less than a year) to charity, you'll get full deductible credit for your cost basis (the $5,000), but you'll give up the ability to deduct your additional $5,000 in gains. Hang on for a full year, though, and you can deduct the full $10,000 (your cost basis plus your investment gain) against your annual income without having to pay a cent of tax on your gains!
Should you gift stock to a beneficiary or family member they, too, will retain your cost basis for as long as they own the stock. When they sell they'll be liable for the tax implications, be it short term or long term. However, gifting stock from a parent or grandparent to a child could be a smart move since a young adult is more likely to be able to sell stock and pay 0% or 15% in long-term taxes since they typically earn less per year than older adults.
Jason Hall: One of the simplest ways that most Americans can make tax-free investments is by opening a Roth IRA. While income limits prevent the highest-income earners from contributing to a Roth, the vast majority of people can contribute $5,500 every year ($6,500 if you're 50 or over) and invest it completely tax free.
Not only will the contributions grow while exempt from taxation, but when you retire and begin taking distributions from a Roth, those distributions arealso not taxed. In short, a Roth IRA is a fantastic tool to grow retirement wealth for tax-free income in later years.
There are income restrictions andother guidelines you need to followto qualify, and you can't deduct the contributions from your income like you might be able to with traditional IRA contributions. However, if your employer offers a retirement plan you probably lose that tax benefit for a traditional IRA anyway.
If that's your situation, I can't think of a good reason why everyone who qualifies shouldn't take full advantage of the tax-free wealth building power of a Roth IRA.
: Along the same lines as Jason mentioned with Roth IRAs, tax laws also make tax-free investment available to those setting money aside for education.
College savings plans, better known as 529 plans, offer the same tax deferral for those saving for college that most investors enjoy when they build up a nest egg in an IRA. Even better, as long as funds are used for qualifying educational expenses, the investment gains are free of federal income tax. Those expenses include not only tuition and required fees but also room and board for those who attend college at least half-time. Books, supplies, and equipment, including computers, can also qualify to the extent that the school sets a budget for such items.
Dozens of 529 plans are available to college savers, with each state having at least one plan. With just a few exceptions, you can generally pick any state's plan you want, and since each plan has a different menu of investment options, shopping around for low fees and strong investment choices is worth the effort. In addition, some states offer additional tax breaks or other incentives to participate. With parent-funded 529-plan money treated as parent assets for financial aid purposes, college savings plans can be the smartest way to set money aside for a child's education.
The article 4 Investments You Can Make Completely Tax Free originally appeared on Fool.com.
Dan Caplinger has no position in any stocks mentioned. Jason Hall has no position in any stocks mentioned. Sean Williams has no position in any stocks mentioned. Selena Maranjian has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.
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