Another strategy for limiting the tax you
owe is to make investments that provide tax-free income.
With Roth IRAs, 529 plans, and education
savings accounts, you pay income tax on the contributions you
make to the account, but no income or capital gains tax on your
income or earnings in the account, either as they accumulate,
or when you make withdrawals, provided you meet the conditions
for those withdrawals.
Municipal bonds
You owe no federal income tax on the interest
you earn from municipal bonds. And if the bond is issued by the
state in which you live, you don’t owe state income tax either.
That’s one reason why tax-savvy investors, especially those
who pay tax at the higher federal rates, often buy municipal rather
than corporate bonds for their portfolios.
One catch to this investment strategy is
that municipal bond interest is subject to the alternative minimum
tax (AMT).
You’ll want to check with your tax or investment
adviser to figure out how to get the benefits of tax-free income
and avoid this potential downside.
