4 Tips for Your Tax-Free Retirement Account

Source: Thinkstock

Source: Thinkstock

Many investors have tax-free retirement accounts such as an IRA that allow them to accumulate assets and collect dividends and capital gains tax free. But not many investors know how to take advantage of this situation because they don’t know how taxes impact their investments. Here are four tips that you can use to take advantage of your tax-free retirement account.

1. Buy limited partnerships and REITS

Limited partnerships and REITs are special kinds of corporations. They don’t have to pay taxes, but they are required to distribute the bulk of their profits to shareholders in the form of a dividend. These dividends are not taxed like normal dividends, but rather as ordinary income. As a result they are priced accordingly. But since the market movers are those who are in the highest tax bracket they are priced thusly, meaning that if you are an investor with a small amount of income, or if you put these assets in a tax-free account such as an IRA, you are getting a bargain.

There are lots of these sorts of assets out there. Make sure you understand what the company does before you invest in it. Also make sure that the distribution is appropriate — i.e. make sure it is not too big. A good way to check for this is to make sure the company is not issuing additional shares or debt on a regular basis in order to make payments.

2. Don’t buy municipal bonds

Municipal bonds are already tax free assets if you buy the municipal bonds from your home state (if you buy municipal bonds from another state you will have to pay state, but not federal taxes). As a result the market has priced this in accordingly. So just to provide you with a rough but simple example, if the tax rate is 50 percent then a corporate bond might yield 5 percent, but a municipal bond with the same amount of risk might be priced so that it yields 2.5 percent. Thus there is no point in buying municipal bonds in a tax-free account.

3. Buy corporate bonds

Corporate bonds are taxed at the ordinary income rate, and like with limited partnerships and REITs they are priced accordingly — i.e. they are discounted in anticipation of taxes. Therefore they are good investments for your tax-free account.

The one issue, of course, is that we live in a world with very low interest rates. Therefore when you pick corporate bonds, you need to buy short-duration issues, meaning that they mature soon. If interest rates rise then you won’t be impacted as much as if you had picked long-duration issues. Also, dig deep — don’t buy bonds of well-known large cap companies. There are plenty of small companies flying under the radar that pay high yields to their bond holders because the large bond funds won’t touch them and because people think that just because they are small they are high risk. Find small companies that have steady cash-flow and strong balance sheets, and you will be fine.

4. Buy gold and precious metals

Gold and silver have outperformed every major U. S. stock market index over the course of the 21st century, and yet now they are despised assets. Both gold and silver have played crucial monetary roles throughout history, and this hasn’t changed simply because the U. S. went off the gold standard. If you think gold is a “barbarous relic” as John Maynard Keynes called it then buy silver, which is rapidly becoming one of the most ubiquitous specialty metals used throughout a plethora of industries. It also trades below the cost of production.

Gold and other precious metals are taxed as collectibles at 28 percent. That’s too high. But they’re taxed at 0 percent in your tax free portfolio. You can buy a fund such as the SPDR Gold Trust (NYSEARCA:GLD) or the iShares Silver Trust (NYSEARCA:SLV). There are also many institutions that offer gold and silver bullion for your IRA. Just make sure you shop around in order to find the least expensive providers of these services, and make sure that any company you choose has been approved by the Better Business Bureau.

Disclosure: Ben Kramer-Miller owns shares in limited partnerships, high yield corporate bonds, and gold and silver coins.

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