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A few days ago, I wrote a post describing the various options available on the market today that people can use for tax-advantaged retirement savings/investing.
Tax-advantaged vehicles provide us as normal individuals, a very powerful strategy to try to optimize the taxes that we ultimately have to pay over our lifetime. However, there are two big problems I have encountered over the past few years (and ones that I am guilty of as well) circling in the air around how people utilize tax-advantaged money vehicles:
In order to address these two problems I have experienced, the purpose of this post will be to review the tax-advantaged savings options on the market today. While doing this, we’ll cover both the advantages and disadvantages of each, but I’ll try to more blatantly call out some of the disadvantages of each vehicle in order to help people know what they are getting in to with the use of red text. I’ll also include my take on how I will or will not incorporate each in to my personal investing/saving strategy at the end of the post.
Let’s get started!
Having covered tax-advantaged retirement vehicles in the post several days ago, we will now continue on with our discussion with several possible options I’ve been investigating recently that are tax-advantaged, but that are not designed so that we are penalized 10% if we want to withdraw our money/earnings prior to 59.5 years old.
As we work through the options, you’ll likely notice that there are some other tax-advantaged investments that I have excluded. Several of these include tax-managed mutual funds/ETFs, Master Limited Partnerships, US Savings Bonds, and REITs. I left these off the list intentionally so I could focus on the vehicles which, in my non-professional opinion, seem to offer the most significant tax-advantages.
Side Note: Before we too deep in to this discussion, I want to point out that these are only options that are tax-advantaged. In other words, if you do not need the tax shelter and are simply looking to aggressively grow your money for long term needs (but you don’t want to be potentially penalized for pulling money out early if needed prior to retirement), a very good option that you can choose is to simply invest in a taxable mutual fund investing account. Any major brokerage offers these. The best offerings in my opinion are with Vanguard and Fidelity due to the low cost nature of their index mutual funds and the fact that you are not charged a trading commission when you purchase their name brand funds. In these taxable accounts, you can invest in pretty much the same equity mutual funds that you can inside an IRA/401k with these same companies. What I’ve realized is that a lot of people forget to consider this option when looking for places to invest their long term savings. Don’t let this happen to you! 🙂
The first tax-advantaged non-retirement account that I want to discuss is whole life insurance. Lately, I’ve spent between 70-100 hours total analyzing whole life insurance as a potentially good place to save money long term. Since sharing that analysis would be a lengthy discussion, I’ll share that in a separate post – on the way soon!
For the purposes of today’s post, we’ll just skim the surface about what whole life insurance offers:
A fairly interesting tax-advantaged investing vehicle that I have only begun to investigate in depth recently is tax-exempt municipal bonds (and the mutual/ETF fund versions therein).
At a high level, municipal bonds (and securities) are issued by local, county, or state government entities to help fund the various projects and improvements they want to take on. These can include building school, highways, sewer systems, or simply funding day-to-day activities.
Even though it may not be absolutely the most efficient, I would prefer to hold bond mutual funds or ETFs instead of the actual bonds themselves. More specifically, if I were to invest in municipal bonds, I would likely want something that is very secure, i.e. short-term bonds.
Since I like Vanguard, I would likely invest in the Short-Term Tax Exempt Bond Fund, Ticker Symbol, VWSTX. The chart below shows how $10,000 initially invested in this mutual fund would have grown from 1989 to the present day.
As you can see below, the growth is very steady, with some leveling off during the hard economic times when interest rates went down to get the economy jump started with easier lending, but hardly any decrease in value. The 22 year average annual return was 6.07%. Pretty solid, right?!
In looking at the numbers in detail, I found that the most money you would have lost in any one month during this 20+ year period was $117.13, corresponding to roughly a 0.56% decrease. Not much at all compared to the volatility of the stock market and that you have $10,000 to start off with! If you’re interesting in look at my investigation in more detail, click here for the Google Docs spreadsheet.
Of course, the tax-shielding and stability (with short term) of municipal bonds is not a free lunch (i.e. there are some disadvantages).
Everyone hopes that their child will get a full scholarship to go to college, but the odds these days do not seem stacked in our favor enough to TOTALLY depend on one of these awards.
By opening a college savings fund through an institution like Vanguard, you can take advantage of tax deferred growth within the account, while still having the luxury to direct the investments the way you want. Just remember that you will want to match the maturity of the investment instrument with the time horizon associated with whenever you child will be going to college in order to maximize returns.
It is also important to remember that although all parents I’m sure would prefer to help their children pay for college, they should only save for their children’s higher education if and only if they are completely satisfied in their progress in saving enough money to secure their own retirement first! None of us will do our children any good if we are depending on them for everything financially for the last 35 years of our lives, right?! Children also have more options in the form of student loans to assist in paying for college, along with having a long time frame that they can use to pay back this form of debt.
Let’s examine some of the specifics of college savings accounts/plans:
Some negative aspects / disadvantages to keep in mind about higher education savings vehicles:
Well – that about wraps things up for tax-advantaged NON-retirement accounts!
In an upcoming post, I’ll also work through two other tax-advantaged options that I did not have room to cover here – trusts and custodial accounts. Keep an eye out for that – on the way soon!
How about you all? Which of these tax-advantaged non-retirement accounts is your favorite/do you use the most and why?
How much do you have invested in retirement accounts vs. non-retirement accounts at the moment?
Share your experiences by commenting below!
***Photo courtesy of http://upload.wikimedia.org/wikipedia/commons/1/17/Singer_City_Investing_Hudson_Terminal_1909_crop.jpg
Hi folks! My name is Jacob. I am the owner and operator of My Personal Finance Journey. I started this blog in January of 2010 and have enjoyed the journey ever since. Since finishing up graduate school in Virginia in 2014, I have been working in biopharmaceutical development in Colorado. You can read more about me and this site here. Please contact me if you have any questions!
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