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Free tax preparation Publication 517 - Additional Material Prev  Up  Next   Home   More Online Publications

Investigate Before You Invest

What do you want to invest in: stocks, bonds, mutual funds? Do you want to open an IRA or buy an annuity? Does your employer offer a 401K? Remember, every investment involves some degree of risk. Most securities are not insured by the Federal government if they lose money or fail, even if you purchase them through a bank or credit union that offers Federally insured savings accounts. Make sure you have answers to all of these questions before you invest:

  • Define your goals. Ask yourself "Why am I investing money?" Maybe you want to save money to purchase a house or to save for retirement. Maybe you would like to have money to pay for your child's education, or just to have a financial cushion to handle unexpected expenses or a loss of income.
  • How quickly can you get your money back? Stocks, bonds, and shares in mutual funds can usually be sold at any time, but there is no guarantee you will get back all the money you paid for them. Other investments, such as limited partnerships, often restrict your ability to cash out your holdings.
  • What can you expect to earn on your money? While bonds generally promise a fixed return, earnings on most other securities go up and down with market changes. Also, keep in mind that just because an investment has done well in the past, there is no guarantee it will do well in the future.
  • What type of earnings can you expect? Will you get income in the form of interest, dividends or rent? Some investments, such as stocks and real estate, have the potential for earnings and growth in value. What is the potential for earnings over time?
  • How much risk is involved? With any investment, there is always the risk that you won't get your money back or the earnings promised. There is usually a trade-off between risk and reward: the higher the potential return, the greater the risk. The federal government insures bank savings accounts and backs up U.S. Treasury securities (including savings bonds). Other investment options are not protected.
  • Are your investments diversified? Some investments perform better than others in certain situations. For example, when interest rates go up, bond prices tend to go down. One industry may struggle while another prospers. Putting your money in a variety of investment options can help to reduce your risk.
  • Are there any tax advantages to a particular investment? U.S. Savings Bonds are exempt from state and local taxes. Municipal bonds are exempt from federal income tax and, sometimes, state income tax as well. For special goals, such as paying for college and retirement, tax-deferred investments are available that let you postpone or even eliminate payment of income taxes.

Compare Investment Vehicles

Not all investment vehicles are created equal or work for your personal financial goals. Some provide steady income and are low risk, but yield small returns on investment; others may provide significant returns, but require a long term investment commitment. There is a wide assortment of investment vehicles available. Some of the most popular include: mutual funds, traditional IRAs, Roth IRAs, savings bonds or bond funds, stocks, and certificates of deposit.

Some investments pay out earnings on a regular (quarterly, monthly, or annual) basis, while others pay out earnings at the end of the investment period or may have age requirements for when you can withdraw your money without a penalty. Make sure your investment income stream matches your investment timeline.

You should also consider the tax ramifications. If you are saving for retirement or for education, consider investments that offer incentives for saving for a particular purpose. Your contributions for some investments are tax deductible, but the earnings are not taxed (e.g. Roth IRA); your contributions to other investments may not be taxed, but the earnings are taxed (e.g. traditional IRA).

You don't have to put all of your money in one investment. Consider diversifying your investment portfolio by placing your money in several investment vehicles. This can protect you from risk; while one of your investments may be performing poorly, another one of your investments can make up for those losses.

Type of Investment What is it? Risk level
Traditional IRA Traditional IRA is a personal savings plan that gives tax advantages for savings for retirement. Investments may include variety of securities. Contributions may be tax-deductible; earnings are not taxed until distributed. Risk levels vary according to the holdings in the IRA
Roth IRA A personal savings plan where earnings that remain in the account are not taxed. Investments may include a variety of securities. Contributions are not tax-deductible. Risk levels vary according to the holding in the IRA
Money Market Funds Mutual funds that invest in short-term bonds. Usually pays better interest rates than a savings account but not as much as a certificate of deposit (CD). Low risk.
Bonds and Bond Funds Also known as fixed-income securities because the income they pay is fixed when the bond is sold. Bonds and bond funds invest in corporate or government debt obligations. Low risk.
Index Funds Invest in a particular market index. An index fund is passively managed and simply mirrors the performance of the designated stock or bond index. Risk level depends on which index the fund uses. A bond index fund involves a lower risk level than an index fund of emerging markets overseas.
Stocks Stocks represent a share of a company As the company's value rises or falls, so does the value of the stock. Medium to high risk.
Mutual funds Invest in a variety of securities, which may include stocks, bonds, and/or money market securities. Costs and objectives vary. Risk levels vary according to the holdings in the mutual fund.

Investing Through Your Employer

Many employers encourage their employees to save for their retirement by establishing 401(k), 403(b), or 457(b) plans. Employees that participate in these programs elect to have a set amount of their income deducted from their paychecks to save for retirement; these amounts are not subject to income taxes. In many cases, your employer will match a portion of the amount of the money that you contribute into your 401(k) account, which is like getting "free" money. If you stop working at a company, remember to take the money from your 401(k) with you. If you "rollover" the total from your old job to an account at your new job, a traditional IRA, you will not have to pay taxes on the money.

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Free tax preparation 11. Free tax preparation   Employer-Provided Educational Assistance Table of Contents Introduction Working condition fringe benefit. Free tax preparation Introduction If you receive educational assistance benefits from your employer under an educational assistance program, you can exclude up to $5,250 of those benefits each year. Free tax preparation This means your employer should not include those benefits with your wages, tips, and other compensation shown in box 1 of your Form W-2. Free tax preparation This also means that you do not have to include the benefits on your income tax return. Free tax preparation You cannot use any of the tax-free education expenses paid for by your employer as the basis for any other deduction or credit, including the American opportunity credit and lifetime learning credit. Free tax preparation Educational assistance program. Free tax preparation   To qualify as an educational assistance program, the plan must be written and must meet certain other requirements. Free tax preparation Your employer can tell you whether there is a qualified program where you work. Free tax preparation Educational assistance benefits. Free tax preparation   Tax-free educational assistance benefits include payments for tuition, fees and similar expenses, books, supplies, and equipment. Free tax preparation Education generally includes any form of instruction or training that improves or develops your capabilities. Free tax preparation The payments do not have to be for work-related courses or courses that are part of a degree program. Free tax preparation   Educational assistance benefits do not include payments for the following items. Free tax preparation Meals, lodging, or transportation. Free tax preparation Tools or supplies (other than textbooks) that you can keep after completing the course of instruction. Free tax preparation Courses involving sports, games, or hobbies unless they: Have a reasonable relationship to the business of your employer, or Are required as part of a degree program. Free tax preparation Benefits over $5,250. Free tax preparation   If your employer pays more than $5,250 in educational assistance benefits for you during the year, you must generally pay tax on the amount over $5,250. Free tax preparation Your employer should include in your wages (Form W-2, box 1) the amount that you must include in income. Free tax preparation Working condition fringe benefit. Free tax preparation    However, if the benefits over $5,250 also qualify as a working condition fringe benefit, your employer does not have to include them in your wages. Free tax preparation A working condition fringe benefit is a benefit which, had you paid for it, you could deduct as an employee business expense. Free tax preparation For more information on working condition fringe benefits, see Working Condition Benefits in chapter 2 of Publication 15-B, Employer's Tax Guide to Fringe Benefits. Free tax preparation Prev  Up  Next   Home   More Online Publications