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How to Legally "Opt Out" of Federal Income Taxes

Thursday, November 7, 2013 6:02

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Editor’s note: Today, we’re wrapping up Dr. David Eifrig’s “miniseries” on one of the market’s top income investments right now – municipal bonds… On Tuesday, we showed you a strategy for timing your muni investments. And yesterday, we showed you a way to buy munis at a big discount. Today, we’re running a classic essay that illustrates exactly how powerful “munis” can be for folks who are looking for safe income.

If you’re a retiree… or if you’re simply looking to earn safe interest on your money… you have two enemies:

1. Federal income tax rates that can take a 20%-30% bite out of your earnings. In some cases, that number is as high as 40%.

2. Interest rates that are near record lows. Right now, you’re lucky if you can make even 1% on your bank savings… And that’s before taxes.

Fortunately, you can fix this situation quickly.

You just need to know how to legally “opt out” of federal income taxes on your savings… and where to find much higher (but still safe) rates of income…

Let me show you what I mean…

Right now, the highest-yielding one-year Certificate of Deposits (CDs) pay about 1%. Most banks offer a little less… But for this example, we’ll use the banks offering the highest yields.

The federal government will tax the income you collect from CDs just like ordinary income. For most folks, this means they must pay Uncle Sam 25%-28% of any interest earned. For high earners, the tax rate is 39.6%. Keep these figures in mind… We’ll come back to them in a moment.

But first, you need to know you have the option of placing your money into another safe investment. This investment pays 6.5%… and the interest is free from federal taxes. If you live in a state with zero income tax (like Florida or Texas), you pay no tax at all.

So… a saver has the option of parking his money in the bank… We’ll call that “option A” – or in this investment… “option B.” Here’s how the numbers stack up after you factor in taxes:

	Option A	Option B
Initial capital	$10,000	$10,000
Annual yield	1%	6.5%
Interest income after one year	$100	$650
After federal income tax (28%)	$72	$650

As you can see, it’s no contest. By owning this safe, alternative investment, you can earn nine times more interest on your savings. For a $10,000 investment, that’s an extra $573 after just one year.

If you’re in a higher income bracket and put in a larger chunk of savings, the numbers get ridiculous. For example, on a $100,000 chunk of savings, you’ll earn nearly $6,000 more a year with this tax-free strategy versus a high-yield CD.

And you can start earning this income RIGHT NOW. It will take you just five minutes. All you need is a regular brokerage account. And all you need to do is buy one of my recommended “muni bond” funds.

As regular readers know, municipal bonds are loans made to state and municipal governments. To encourage folks to invest in the government, interest received from “munis” is exempt from federal income tax. And again, if you live in a zero-income-tax state, you’ll pay $0 in taxes on your income.

Right now, one of my favorite muni-bond funds, the Invesco Insured Municipal Income Trust (IIM), is offering you 6.5% in annual interest. By buying this fund, you park your money in loans to various state and local entities. It’s a diversified fund that owns over 300 different bond issues. And as of yesterday, it’s even trading at a small discount to the value of its bonds.

Of course, unlike a traditional CD, there’s no guarantee that the price of the fund won’t fall. So this isn’t something you want to put ALL your savings into. But these bonds are backed by the taxing power of state and local governments. And they’re insured against default. A fund like IIM is a safe choice for a good portion of your portfolio (up to 5%).

If you’ve earned and saved your whole life and would like to earn income on those savings, stop shortchanging yourself. Consider “opting out” of federal taxes and moving some of your savings into a muni-bond fund.

It’s safe… and you can start earning nearly nine times more income than you do in the bank.

Here’s to our health, wealth, and a great retirement,

Dr. David Eifrig

Source: http://www.stansberryresearch.com/dailywealth/2580/how-to-legally-opt-out-of-federal-income-taxes

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