What Tax-Advantaged Alternatives Do I Have?

A strong savings program is essential for any sound financial strategy.

We take Benjamin Franklin’s saying to heart, “A penny saved is a penny earned,” and we lay away our spare cash in savings accounts and certificates of deposit.

Those investors who’ve accumulated an adequate cash reserve are to be commended.

But as strange as it sounds, it is possible to save too much, or rather, to save what we should be investing.

That may not sound like much of a problem — but it can be.

You see, many investors simply put their savings into the most convenient and secure financial instrument they can find. As often as not, that turns out to be certificates of deposit.

Certificates of deposit are FDIC insured and offer a fixed rate of return, whereas both the principal and yield of an investment in securities will fluctuate with changes in market conditions. When liquidated, the investor may receive back more or less than the original investment amount.

Unfortunately, placing all your savings in taxable instruments like certificates of deposit can create quite an income tax bill.

In an effort to ensure security, some investors inadvertently produce a liability.

It’s a bit like turning on all the taps in your house just to make certain the water’s still running. Sure, you’ll know that the water’s still running, but a lot of it will go down the drain.

The solution is simply to turn off some of the taps.

There are a number of very secure financial instruments that will enable you to defer income taxes. By shifting part of your cash reserves to some of these instruments, you can keep more of your money working for you — and turn off the taps that hamper your money’s growth.

There are a number of tax-advantaged investments you can consider for at least a portion of your savings portfolio.

One possibility you may want to consider is a fixed-annuity contract.

Annuities are long-term financial products designed for retirement purposes.  In essence, annuities are contractual agreements in which payment(s) are made to an insurance company, which agrees to pay out an income or a lump sum amount at a later date.

Fixed-annuity contracts accumulate interest at a competitive rate. And the interest on an annuity contract is usually not taxable until it is withdrawn.  There are contract limitations and fees and charges associated with annuities, which include, but are not limited to, mortality and expense risk charges, sales and surrender charges, administrative fees, and charges for optional benefits. 

Also, withdrawals from an annuity are reported as income and subject to ordinary tax treatments and if made prior to age 59¹/2 may be subject to a 10 percent penalty.

Another possible tax-advantaged investment is municipal bonds, which are one of the most popular tax-exempt investments available. They are issued by state and local governments and are generally free of federal income taxes. In addition, they may be free of state and local taxes where they are issued.

Municipal bonds can be purchased individually, through a mutual fund, or as part of a unit investment trust.

Income from municipal bonds and municipal bond funds may be subject to federal, state, or local alternative minimum tax. Also, if you sell a municipal bond or shares in a municipal bond fund at a profit, there are capital gains to consider.

There are a number of other tax-advantaged investments you can consider. If your savings portfolio is generating a tax liability, you may want to consider the alternatives offered by tax-advantaged investments.

This material was written and prepared by Emerald Publications.

GE 37851 (02/07)