Tax Advantaged Investments

When it comes to investing, it's not just how much you make that matters; it’s how much you keep after taxes that matters more.

Investment accounts can be divided into two main categories, taxable accounts (like a brokerage account, banks, mutual funds) and tax-advantaged accounts.

Tax advantaged account can be broken down into the following sub-categories: tax-deferred, tax-exempt, others. And these are usually provided for by governments or the like agencies.

Tax deferred retirement accounts
This simply means that you’ll pay taxes later. Your investment (income) in the account will not be taxed until it is withdrawn.

Examples of this are the U.S.’s 401Ks (Employer established plan) and the IRAs (Individual Retirement Accounts).

Tax free accounts
A tax-exempt or tax-free investment is one where current income earned on the investment is of course not taxed.

Canada’s Tax-free Savings Account (TFSA) which gives investors the advantage of not paying taxes even at withdrawal.

U.S. also has the 403(b) plan, also known as a tax-sheltered annuity (TSA) plan, is a retirement plan for employees of public schools, and of certain tax-exempt organizations.

Other Types
These schemes are hybrids or are simply different from the normal tax free/deferred accounts. In the Philippines, we have multiple options:

Pag-ibig HDMF (Home Development Mutual Fund) – a Philippine government-owned and controlled corporation offers a fund called MP2. A voluntary high yield savings account with tax-free dividend yields (5-7% dividend rates & 5-yr maturity).

SSS (Social Security System) Flexi and Peso Funds – the flexi fund is for Overseas Filipino Workers (invested in 91-day T-Bills); while the Peso fund is invested in 5-yr T-bonds and 365 T-bills; no tax charged for contributions, interest.

PERA (Personal Equity Retirement Account) gives a 5% tax credit of annual contributions every year and tax exemption on income and withdrawal after retirement (Age 55).

Tax Efficient Accounts
The goal for this is to make it tax efficient – you still pay taxes but at a lower rate. Investments that minimize trading activity and offset gains with losses will result in lower taxation such as low-cost index funds under ETFs and Mutual Funds. ETFs however are more tax efficient than MFs as taxes gained are due only when the fund is sold which gives a tax-deferred advantage.

There are some mutual funds called ‘Tax-Managed Fund’ which are designed to specifically minimize the investors’ tax burden. However, these are typically more expensive due to the specialized service attached – this will make more sense if you have higher income than the the average person and in a higher-tax bracket.

REITs or REIT-ETFs offer tax-efficient exposure to the real estate market as well.

The non-taxables
All types of income or services are taxable unless specifically excluded by law. But, there always
exceptions.

Insurance Proceeds – not taxed in most cases (there are exceptions here as well), other than dividends or premium refunds.

• Riders – Pay-outs for disability, Critical-Illness, Hospitalization and the like
• Employer Provided Insurance (Life/Health) – this is not included in your income

Other Tax-exempt securities –

• Municipal Bonds – This is used to finance capital expenditures of local governments and Interest earnings are usually tax-free.
• Tax-Exempt Money market funds – MMFs are invested in a wide range of securities and have low returns. Mainly used to park cash.
• Health Savings Account (HSA) – money used for medical expenses, compounded tax free.

These are options for you to consider, for a much more detailed analogy and whether these fit your goals, it is best to ask a Tax Professional on this.