How to Invest in Tax-Free Savings Accounts

A tax-free savings can be a municipal bond, a money market fund that contains municipal funds or a federally qualified tax-free savings such as a Roth or health savings account. All of these serve a different purpose. For instance, the Roth is a retirement account, so there's a 10 percent penalty on any money you remove that's more than your initial investment. Health savings accounts are tax-free savings you use to pay medical expenses. The tax-free mutual funds and money market contain municipal bonds, debt issued by states or municipalities. Tax-free money market accounts resemble bank savings the most.

Check to see if your tax bracket warrants a tax-free fund. To compare a taxed interest rate to an untaxed one, you subtract your top tax bracket from 1. If you're in a 25 percent federal tax bracket, your answer will be 0.75. You then divide the yield of the tax-free fund by that number. If you had a tax-free yield of 3 percent, you'd have to get a 4 percent taxed return to equal the amount you keep after taxes.

Find the right account to serve your needs. If you simply want a tax-free savings that's similar to a regular savings account, a municipal money market is the most similar. These are not bank products, since they contain municipal bonds, but the investment department of banks may offer them. You can also find them at brokerage houses. Read the prospectus and check the returns. Find out how many checks you can write each month, the account minimum investment, the minimum check size and any fees, in addition to finding the interest rate.

Request an application to open an account once you find the right fund. Normally these accounts have no load, a charge for investing. Make sure the one you selected follows that pattern. Also, see if there's a set-up fee or maintenance fee. Normally, these types of funds don't have any. You'll need your Social Security number, legal name, birthday and address to fill out the form. If you open an account with a joint owner, both of you must provide that information and sign the forms.

Submit a check for your initial deposit. Some companies have low limits for additional deposits if you have the money automatically removed from another checking or savings each month.

Wait for your checks to arrive in the mail and your statement of account. Often you can track your funds online at your mutual fund website or the brokerage house that holds the funds. Store your checks in a safe place. You use these to remove money in lieu of withdrawal slips.

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