When two income-earning individuals become a couple, they might find themselves suddenly interested in ways to reduce taxes on their savings. Unlike investments such as stocks and bonds, savings should be dependable and as low-risk as possible. Savings should be accessible without advance notice should emergencies arise, although there might be a penalty involved for early withdrawal. Within these constraints, there are several tax-free options available to savers.
U.S. Savings Bonds
The interest paid by savings bonds is free from state and local tax, and savings bonds have a tax-saving feature that helps pay for educational expenses. If you are at least 24 years old when you buy the bonds, you can use the money you receive when you redeem the bonds toward higher education expenses and avoid all taxes on your interest income. If you plan to use the bonds to pay for a child’s college costs, the Internal Revenue Service forbids the child from being the co-owner of the bonds, but the child can be the bond beneficiary. You cannot cash in your savings bonds for one year, and will be penalized three months of interest if you redeem them within the first five years. Savings bonds pay interest for 30 years.
Tax-Free Money Markets
A money market fund is composed of very short-term debt instruments, often with a maturity period measured in days or weeks. A tax-free money market consists of municipal short-term debt issued by the state or city in which you live. These debt issues are free from all taxes for local residents. Although not government-insured, as would be a bank money market, the tax-free versions may be insured by the Securities Investor Protection Corporation, which covers most mutual funds and brokerage accounts.
Roth Individual Retirement Account
Another way to avoid paying interest on savings is put money into a Roth individual retirement account. The money you place in a Roth IRA has already been taxed and can grow and be withdrawn tax free. You can purchase certificates of deposit in your Roth IRA that are insured by the Federal Deposit Insurance Corporation. The FDIC will insure at least $250,000 in interest-bearing deposits registered in your own name. The maximum contribution to a Roth IRA in 2013 is $5,500, or $6,500 for individuals over 50 years old. Limits on modified adjusted gross income, or MAGI, for 2013 start at $59,000 for individuals and $178,000 for couples. Two caveats regarding Roth IRA: to enjoy the tax-free benefits, you must keep the money in the account for five years. Also, you will be taxed if you withdraw funds before age 59 ½ unless you have good cause, such as disability or buying your first home. A Roth IRA might work for savers who can tie up part of their savings for longer periods of time.
A close cousin of the Roth IRA is the Roth 401(k), which is a workplace retirement account. Although they share the same tax advantages, five-year waiting period and age 59 ½ rules, they differ in their income and contribution limits. The contribution limits for a Roth 401(k) are subject to change every year. As of 2013, they were $17,500 for individuals under 50 years of age and $23,000 for older employees. There are no income limits on Roth 401(k) accounts.
Savers Tax Credits
If you contribute to an IRA or 401(k) account, you may be eligible for a $1,000 tax credit, or $2,000 for couples. The 2013 modified adjusted gross income limits for this credit were $29,500 for individuals and $59,000 for couples. To receive the maximum credit, you must contribute $2,000 to your retirement account. To apply, taxpayers need to fill out IRS Form 8880.
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