Tax Exempt vs. Tax Deferred Income

moneyIt’s tax time and everyone wants to know how to reduce their income tax liability. While it may be too late to make changes that impact 2014, you’ve got plenty of time to make changes for 2015. As you do so, keep in mind the differences between tax exempt and tax deferred income.

Tax exempt income:

Many tax-exempt investments are available that provide interest without taxation. Most common are municipal bonds issued for various government operations like building roads, schools, libraries, etc. These are issued free of federal tax, and may also be free of city and state taxes if the purchaser resides in the locale. Your financial planner will guide you with selecting the best tax exempt investments for your portfolio by comparing the after-tax return rate with other investments of similar risk, so you receive the best return available.

Your financial planner will also advise that though the interest is tax exempt, you may be liable for capital gains tax when these bonds are sold. Tax free growth is one of the most potent investment opportunities available, but there are many rules and tactics to contemplate when considering tax exempt income, and your advisor will help you select the best choice for you.

Tax-deferred income:

With tax deferred income, the return on these investments is not taxed until it is withdrawn. Therefore, earnings continue to grow without the restriction of taxation, making these investments another formidable opportunity for investment growth. As these investments have a time-value advantage, your estate may not need to withdraw any earnings for quite a while, at which time you may be retired and in a lower tax bracket.

The preceding text is an excerpt from “Exit Insight: Getting to ‘Sold!’” by author Joseph M. Maas, available for purchase online at Merrell Publishing or Amazon.