Best Practices for Creating an Efficient Tax Investment


Everyone wants to save money on their taxes. But how do you do that? One of the best ways is through tax-efficient investments. Essentially, this is a legal method of tax avoidance, by storing assets to limit your future tax liability. 

However, creating tax-efficient investment vehicles should never be confused with tax evasion. Tax evasion is an illegal process of purposefully concealing income or assets from the IRS, resulting in fines, and even prison time.

Here, we’ll dive into the many ways to ethically and legally lower your taxes.


Overview of Legitimate Tax Investments

Tax-efficient investment vehicles either reduce the amount of tax you owe, or defer your taxes to a future period. There are a number of ways of creating tax-efficient investments for individuals and businesses. This gives you more post-tax income, which you can keep or reinvest. It’s a win-win situation. 

Below is a summary of some common ways of creating a tax investment. Each type works differently, but they usually offer some kind of benefit, like tax reduction or exemption.

Retirement accounts. Contributions to IRA or 401(k) accounts reduce your taxable income, and defer taxes until you make a withdrawal.

Municipal bonds. These bonds earn tax-exempt interest.

Real estate investments. Property is an asset that depreciates over time to reduce your taxable income.

Health saving accounts. Contributions to HSAs for qualified medical expenses are tax-exempt.

Life insurance and annuities. Life insurance grows tax-exempt cash value, and allows you to transfer a benefit to beneficiaries without paying income tax. 

Other methods are less common, and include charitable donations, foreign investments, mutual funds, or donations to conservation easements. 

Retirement Accounts 

By contributing to a 401(k), 403(b), Individual Retirement Account (IRA), or Roth IRA, you’re creating a tax shelter by deferring or exempting your income from taxes.

Contributions to a 401(k) and traditional IRA account that do not exceed the limit are not taxed until you retire and withdraw funds. As such, they allow you to defer taxes. How much tax you pay on withdrawal depends on your tax bracket, which is usually lower in retirement than it is while you are earning income. 

In the case of a Roth IRA, contributions are taxed before going into the account, and any withdrawals you make after retiring are tax-exempt. This means you pay now and save later, when you retire. 

Contribution limits and withdrawal rules

The advantage of a retirement account as a tax investment is that anyone can open one – as long as you have earned income. However, there are limits on how much you can pay into these accounts. 

Currently, you can contribute up to $22,500 pre-tax to a 401(k). Contributions below this limit are subtracted from your taxable income, and lower your tax liability. 

Depending on your age, you can contribute up to $7,500 to an IRA, provided that you earn at least that amount in taxable income in the year. The limit will be lower if you earn less. Come tax time, you can deduct the amount you contributed throughout the year on your tax return.

How much you contribute to a Roth IRA is limited by your income. Currently, your Modified Adjusted Gross Income (MAGI) must be under $153,000 for this tax year, and below $161,000 for the 2024 tax year.


Municipal Bonds

Municipal bonds are usually a type of debt security or loan issued by local, county, and state governments, to pay for public works. They are a great way of creating a tax-efficient investment, particularly for high-income individuals, as many are tax-exempt. This means that the interest generated by these bonds is not subject to federal income taxes. They are also tax-exempt from some state and local taxes. 

These bonds are often categorized based on the source of their interest payments and principal repayments. They can also be structured in a variety of ways. 

The two most common types of municipal bonds are General Obligation (GO) bonds, and Revenue bonds. 

GO bonds are issued by municipalities and are not secured by any assets. They’re issued based on the creditworthiness and taxing power of a municipality. Generally, they fund projects that don’t generate revenue, like public schools or government buildings.

Revenue bonds are issued to fund specific revenue-generating projects like roads or airports. As such, repayment comes from revenue generated by the project, and not from the issuing authority.


Usually, municipal bonds are issued in $5,000 increments, with term lengths of two to 30 years. They can be purchased individually, or through mutual funds or exchange-traded funds (ETFs).

The return on municipal bonds is calculated based on its tax-equivalent yield (TEY), which is divided by your current tax rate subtracted from 1. For example, if you fall under the 35% tax bracket and buy a bond yielding a 4% return, you would calculate as follows: 4/ (1-0.35) = 6.15%.

How municipal bonds differ from taxable bonds

Taxable bonds, as the same suggests, are loans with a return that is subject to taxes. This can be at the local, state, or federal level, or a combination.

Because municipal bonds generate tax-free income, they usually have lower interest rates than taxable bonds. Municipal bonds are also considered a lower-risk investment than taxable bonds, because of the types of projects they fund.


Real Estate Investments

There are several ways of creating tax-efficient investments in real estate. This is also a relatively safe method, as property is always in demand!

If you buy a property that will not generate income using a mortgage, you can deduct the portion of your payment that is attributable to interest and property taxes. On the other hand, an income-producing rental property can reduce your tax liability through depreciation deductions

Moreover, you may be entitled to benefits if you perform a 1031 like-kind exchange. This allows the sale of a property and avoidance of capital gains, if the proceeds are used to purchase a similar asset.

And if you’re a landlord or real estate investor, you’ll also be able to reduce your taxable income by deducting rental losses from your rental income. 

But that’s just the start! Depending on whether you’re an investor or homeowner, you can write off a number of other expenses, including:

  • Mortgage interest payments 
  • Repairs and maintenance
  • Property taxes
  • Operational costs 

Speak to your CPA to see how best to handle your real estate investment. 

A note on property laws

Before investing in real estate for a tax-efficient investment vehicle, you need a thorough understanding of property law, and the many deductions are credits you can apply for. That way, you can write off expenses correctly, and avoid potential penalties. 

This may mean that you’ll need to consult with a CPA or tax advisor to verify any laws, and ensure you remain compliant. 


This includes being aware of the differences between rental and owner-occupied properties. 


Health Savings Accounts

Health Savings Accounts (HSAs) are designed to help you pay for qualified medical expenses. They’re a useful way of creating a tax efficient investments, as they feature a triple tax advantage:

  1. Any contributions you make to your HSA reduce your taxable income.
  2. The investment growth of HSAs is tax-exempt.
  3. Qualified withdrawals for medical expenses are tax-exempt. 

A great aspect of an HSA is that your employer can make contributions on your behalf, and the account stays with you even if you change employers. 

It’s also worth noting that you can make a withdrawal from your HSA at any time for qualifying expenses that have not been reimbursed, as long as you can provide the necessary receipts as evidence. 

Eligibility criteria and contribution limits

To open a HSA, you must have an eligible high-deductible health plan (HDHP). An HDHP has a minimum deductible of $1,500 for an individual plan or $3,000 for a family plan, along with a maximum out-of-pocket limit of $7,500 for an individual plan or $15,000 for a family plan.

You can’t open an HSA if you have other health coverage or MediCare. You also need to ensure that your medical expenses qualify for coverage according to the IRS, as there are exclusions. 

In addition, there’s a limit to contributions made for HSAs. For the 2023 tax year, you can contribute up to $3,850 for an individual plan, and up to $7,750 for a family plan. If you’re 55 or older, you can contribute an extra $1,000 to an individual or family plan. 


Life Insurance and Annuities

Certain life insurance policies and annuities can serve as tax-efficient investments. Basically, the interest earned on life insurance policies and annuity contracts is exempt from local, state, and federal taxes, on the condition that it stays in your policy. Thereafter, it’s tax-deferred. 

Annuities feature the added advantage of having no mandatory distribution age, so you can keep growing your funds after you retire. 

With life insurance policies, you can withdraw an amount up to your premium payments without having to pay taxes. The death-benefit payout of these policies is also exempt from income tax, regardless of the size of the payout. However, these funds may be subject to estate taxes. Thankfully, the level of exemption for estate tax is very high. 

When it comes to limits, the IRS caps tax-deductible contributions to annuities in the same way as 401(k) plans. For the 2023 tax year, this is $22,500, and will increase to $23,000 in the 2024 tax year. 


Tax Investments for Business Owners

While having a business comes with greater tax responsibilities, it also offers more tax benefits. This includes creating a tax shelter. 

Different business entities offer different benefits. For example, if you report business income for sole proprietorships, partnerships, SMLLCs or S corps on your personal tax return, you may be eligible to claim the qualified business income (or Section 199A) deduction. This allows you to deduct up to 20% of self-employed income on your taxes. 

However, this does not include the following: 

  • Capital gains or losses
  • Dividends
  • Interest income
  • Income earned outside the US

Businesses can also make use of a number of tax deductions and credits to reduce their tax liability, including home office deductions, electrical vehicle credits, as well as section 179 and depreciation

If you’re unsure of whether your business qualifies for credits and deductions, speak to your CPA. 


Risks and Considerations

Despite the many benefits of creating a tax-efficient investments, there are risks. This primarily includes aggressive tax avoidance measures that may be seen as tax evasion by the IRS. 

The IRS distinguishes between tax sheltering and “abusive” tax sheltering. For example, overclaiming deductions or hiding income and assets from taxation. 

Moreover, illegal tax shelters are treated as fraudulent activity. This means you could face a penalty of 75% of your underpaid tax, and possible criminal prosecution.


For this reason, it’s essential to consult an expert when creating tax-efficient investments and to ensure that it is legal and ethical. A CPA or tax expert can also help you stay up to date with any changing laws, regulations and best practices around creating a tax shelter and lowering your tax liability. 

For help with creating a tax-efficient investments to lower your taxes, schedule a Discovery Call with one of our CPAs.

Schedule a Discovery Call

The information presented in this blog article is provided for informational purposes only. The information does not constitute legal, accounting, tax advice, or other professional services. We make no representations or warranties of any kind, express or implied, about the completeness, accuracy, reliability, suitability, or availability of the information contained herein. Use the information at your own risk. We disclaim all liability for any actions taken or not taken based on the contents of this blog. The use or interpretation of this information is solely at your discretion. For full guidance, consult with qualified professionals in the relevant fields.