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6 ways to earn tax-advantaged income

Explore creating an income stream with tax benefits.

Key takeaways

  • Municipal and US government bonds offer varying tax advantages. If your bond income is taxable, holding those assets in a tax-advantaged account like an IRA can shield interest income from immediate taxation.
  • Separately managed accounts may help you manage gains and harvest tax losses.
  • Qualified dividends are taxed at long-term capital gains tax rates.
  • Higher-income investors may want to consider tax-deferred annuities to help them defer taxes on investment gains.

Taxes can quietly erode your investment income—but they don’t have to. With a few smart strategies, you may be able to build a stream of income that receives preferential tax treatment.

These 6 tips can help you make your income portfolio more tax-efficient, whether you're investing in bonds, dividends, or managed accounts.

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1. Municipal bonds

Municipal bonds, or "munis," offer interest income that is generally exempt from federal income tax, and often from state and local taxes if you reside in the state that issued the bonds. This makes them especially attractive for high-income investors, and those in states with higher tax rates. While muni coupon yields may be lower than those of taxable bonds, the difference in tax treatment may help offset those lower yields. To see how yields compare, try Fidelity’s taxable equivalent yield calculator.

You can invest in munis by buying individual bonds, bond funds, or ETFs, or through separately managed accounts. Learn more about Fidelity’s municipal bond SMAs: Fidelity’s Intermediate Municipal Strategy and Fidelity® Limited Duration Municipal Strategy.

Read more in Fidelity Viewpoints: Your complete guide to municipal bonds.

Graphic compares after-tax income from municipal bonds vs. taxable bonds across federal tax brackets.
Hypothetical example for illustrative purposes only. This hypothetical example shows annual income from a $10,000 investment in a taxable account and the impact on that income from the 4 highest federal tax rates plus the inclusion of the net investment income tax (NIIT). The municipal bond investment has a 2.63% assumed yield and the taxable US Treasury yield is assumed to be 4.34% (data sourced from LSEG TM3, formerly Refinitiv TM3, as of 11/30/23). Actual investments may vary. It does not reflect the impact of state taxes, federal and/or state alternative minimum taxes, tax credits, exemptions, fees, or expenses. If it did, after-tax income might be lower. Please consult a tax professional for further details.

2. US Treasurys

US Treasury securities are exempt from state and local taxes, though they are subject to federal taxes on ordinary income and net investment income. For investors in high-tax states, this can make Treasurys a more efficient fixed income choice. They also offer safety and liquidity, making them a solid core holding in tax-aware fixed income portfolios. (Read more about the best states for taxes and the best states for taxes in retirement.)

Newly issued Treasurys can be purchased at auctions held by the government, while previously issued bonds can be purchased on the secondary market. Both types of orders can be placed through Fidelity.

Types of Treasurys

Treasury Minimum denomination Sold at Maturity Interest payments
US Treasury bills 1 bond ($1,000 face value) Discount 4-, 6-, 8-, 13-, 17-, 26-, and 52-week Interest and principal paid at maturity
Cash management bills 1 bond ($1,000 face value) Discount Variable and not issued on a regular schedule Interest and principal paid at maturity
US Treasury notes 1 bond ($1,000 face value) Coupon 2-, 3-, 5-, 7-, and 10-year Interest paid semi-annually, principal at maturity
US Treasury bonds 1 bond ($1,000 face value) Coupon 20-year, and 30-year Interest paid semi-annually, principal at maturity
Treasury inflation-protected securities (TIPS) 1 bond ($1,000 face value) Coupon 5-, 10-, and 30-year Interest paid semi-annually, principal redeemed at the greater of their inflation-adjusted principal amount or the original principal amount
US Treasury floating rate notes (FRNs) 1 bond ($1,000 face value) Coupon 2 years Interest paid quarterly based on discount rates for 13-week Treasury bills, principal at maturity

3. Taxable bonds and CDs in tax-advantaged accounts

Placing taxable bonds and CDs in tax-advantaged accounts like IRAs or Roth IRAs can shield interest income from immediate taxation. This strategy helps maximize the compounding effect of any reinvested interest and avoids the drag of annual tax payments. Conversely, consider using tax-efficient assets like index funds in taxable accounts, which may help optimize your overall portfolio.

Read more about tax-smart asset location.

Illustration shows how separately managed accounts work, allowing tax-loss harvesting and gain management.
Chart is for illustrative purposes only. There are no guarantees as to the use or effectiveness of the tax-smart investing techniques, including the coordinated use of different account types and investments, in an effort to reduce a client's overall tax liabilities.

4. Separately managed accounts

Separately managed accounts (SMAs) may use a range of tax-efficient investment techniques in an effort to increase after-tax returns.1 This includes tax-loss harvesting, a method for reducing annual capital gains tax by selling holdings that have lost value to offset realized taxable gains. If you have a net realized loss at the end of the year, you can deduct up to the lower of either $3,000 ($1,500 if married filing separately) or your total net realized losses from your ordinary income and carry forward any remaining unused losses to future years. Net result: Less money goes to taxes today.

For investors who aren’t interested in doing the work of tax-loss harvesting themselves, an SMA makes it possible to better manage taxable gains. SMAs also offer transparency and control over the timing of taxable events.

Investors with Fidelity can consider either a traditional separately managed account, which pairs you with an advisor to develop your strategy, or an online-only option.

Read more about SMAs or digital managed accounts.

Graphic shows investments with tax-exempt income those held long term are more appropriate in taxable accounts, while investments with income taxed at ordinary income rates are more appropriate in tax-advantaged accounts.

5. Qualified dividends

Not all dividends are taxed equally. Qualified dividends—typically paid by US corporations and held for a minimum period—are taxed at long-term capital gains rates, which are lower than ordinary income rates. Investing in companies with a history of paying qualified dividends can enhance after-tax returns, especially in taxable accounts.

See which stocks may pay the highest dividends.

What are qualified dividends?

Required holding period Common stock: 61+ days during the 121 days beginning 60 days before the ex-dividend date. Preferred stock: 91+ days during the 181 days beginning 90 days before the ex-dividend date.
Payer Must be a US corporation, foreign corporation whose country qualifies with the tax treaty with the United States, or foreign corporation whose stocks, such as ADRs, are readily traded on established US stock exchanges.
Exceptions Dividends paid by real estate investment trusts (REITs), master limited partnerships (MLPs), employee stock options, and tax-exempt companies are typically not considered qualified dividends.
Taxation Taxed at lower capital gains tax rates, which range from 0% to 20%. Ordinary dividends are subject to income tax rates, which can be as high as 37%, depending on your income. The 3.8% net investment income tax may also apply.

6. Tax-deferred annuities

While not for everyone, tax-deferred annuities can be useful for investors looking to defer taxes on investment gains—particularly for high-income investors who already contribute the maximum to tax-advantaged retirement accounts.

When you put a portion of your savings into a tax-deferred variable annuity, any earnings are tax-deferred.2 At a future date, you can convert to an income annuity to create a regular income stream or take withdrawals as you need them. At that point any earnings will be taxed as ordinary income.

Tax-deferred annuities are best used when other tax-advantaged accounts, like your 401(k) or IRA, are maxed out, and when paired with a clear plan for withdrawal timing and income needs.

Read more about tax-deferred annuities.

Hypothetical example: The power of tax deferral 3, 4

Graphic shows a hypothetical comparison of investment growth in taxable vs. tax-deferred annuity over 20 years.
This hypothetical example is not intended to predict or project investment results. Your actual results may be higher or lower than those shown here. Assumptions included: $100,000 investment, 20-year horizon, 0.25% annual annuity charge for the tax-deferred variable annuity (VA), marginal federal income tax rate of 32% for the entire period, and a 6% annual rate of return (equivalent to a 5.74% net annual rate of return for the VA) with the gain assumed to derive entirely from income (characterized for tax purposes as ordinary income; for example, bond portfolio income). Investments that have the potential for a 6% annual rate of return also come with the risk of loss. This rate of return is not guaranteed.

The bottom line

Whether you're just starting out or managing a complex portfolio, tax-aware investing can help you make the most of your money. By aligning your investment strategy with smart tax practices, you can build a portfolio that’s both efficient and resilient.

Discover tax-smart investing

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More to explore

1. Tax-smart (i.e., tax-sensitive) investing techniques, including tax-loss harvesting, are applied in managing certain taxable accounts on a limited basis, at the discretion of the portfolio manager, primarily with respect to determining when assets in a client's account should be bought or sold. Assets contributed may be sold for a taxable gain or loss at any time. There are no guarantees as to the effectiveness of the tax-smart investing techniques applied in serving to reduce or minimize a client's overall tax liabilities, or as to the tax results that may be generated by a given transaction. 2. Withdrawals of taxable amounts from an annuity are subject to ordinary income tax, and, if taken before age 59½, may be subject to a 10% IRS penalty. 3. In the taxable account, it is assumed taxes incurred on the income are paid annually from the income itself, with the remainder reinvested. For the VA, it is assumed that all income —less the 0.25% annual annuity charge—is reinvested. The VA pre-tax results assume, the investor has not taken any withdrawals and all taxes continue to be deferred. The VA post-tax results assume, the investor liquidates the VA at the end of time period and pays taxes on the gain out of the proceeds. If the assets in the VA were liquidated entirely in one year, its proceeds may increase the tax bracket to the marginal federal income tax rate of 40.8% (37% ordinary income tax plus 3.8% Medicare surtax), which would minimize and potentially eliminate any savings of the VA. To avoid this, the VA would need to be liquidated over the course of several years or annuitized, which would lengthen the deferral period. 4. State and local taxes, the 3.8% Medicare surtax, inflation, and fund and transaction fees were not taken into account in this example; if they were, performance for both the taxable account and the VA would be lower. This example also does not take into account capital loss carry forwards or other tax strategies that could be used to reduce taxes that could be incurred in a taxable account; to the extent they apply to your situation, the comparative advantage of a VA would be diminished. Lower maximum tax rates on capital gains, dividends, and interest income would make the taxable investment more favorable. Changes in tax rates and tax treatment of investment earnings may impact the comparative results. Consider your current and anticipated investment horizon and income tax bracket when making an investment decision, as the illustration may not reflect these factors. VAs are generally not suitable for investors with time horizons of less than 10 years.

​As with all your investments through Fidelity, and in connection with your evaluation of the security, you must make your own determination whether an investment in any particular security or securities is consistent with your investment objectives, risk tolerance, and financial situation. Fidelity is not recommending or endorsing this investment by making it available to its customers.

Past performance is no guarantee of future results.

Investing involves risk, including risk of loss.

Views expressed are as of the date indicated, based on the information available at that time, and may change based on market or other conditions. Unless otherwise noted, the opinions provided are those of the speaker or author and not necessarily those of Fidelity Investments or its affiliates. Fidelity does not assume any duty to update any of the information.

In general, the bond market is volatile, and fixed income securities carry interest rate risk. (As interest rates rise, bond prices usually fall, and vice versa. This effect is usually more pronounced for longer-term securities.) Fixed income securities also carry inflation risk, liquidity risk, call risk, and credit and default risks for both issuers and counterparties. Unlike individual bonds, most bond funds do not have a maturity date, so holding them until maturity to avoid losses caused by price volatility is not possible.

Interest income earned from tax-exempt municipal securities generally is exempt from federal income tax and may also be exempt from state and local income taxes if you are a resident in the state of issuance. A portion of the income you receive may be subject to federal and state income taxes, including the federal alternative minimum tax. You may also be subject to tax on amounts recognized in connection with the sale of municipal bonds, including capital gains and “market discount” taxed at ordinary income rates. Market discount arises when a bond is purchased on the secondary market for a price that is less than its stated redemption price by more than a statutory amount. Before making any investment, you should review the relevant offering's official statement for additional tax and other considerations.

The municipal market can be adversely affected by tax, legislative, or political changes, and by the financial condition of the issuers of municipal securities. Investing in municipal bonds for the purpose of generating tax-exempt income may not be appropriate for investors in all tax brackets or for all account types. Tax laws are subject to change, and the preferential tax treatment of municipal bond interest income may be revoked or phased out for investors at certain income levels. You should consult your tax advisor regarding your specific situation.

Investing in a variable annuity involves risk of loss – investment returns, contract value, and, for variable income annuities, payment amounts are not guaranteed and will fluctuate.

Guarantees apply to certain insurance and annuity products and are subject to product terms, exclusions and limitations and the insurer's claims paying ability and financial strength.

Fidelity does not provide legal or tax advice. The information herein is general and educational in nature and should not be considered legal or tax advice. Tax laws and regulations are complex and subject to change, which can materially impact investment results. Fidelity cannot guarantee that the information herein is accurate, complete, or timely. Fidelity makes no warranties with regard to such information or results obtained by its use, and disclaims any liability arising out of your use of, or any tax position taken in reliance on, such information. Consult an attorney or tax professional regarding your specific situation.

"Fidelity Managed Accounts" or "Fidelity managed accounts" refer to the advisory services provided for a fee through Strategic Advisers LLC (Strategic Advisers), a registered investment adviser. Brokerage services provided by Fidelity Brokerage Services LLC (FBS), and custodial and related services provided by National Financial Services LLC (NFS), each a member NYSE and SIPC. Strategic Advisers, FBS, and NFS are Fidelity Investments companies.

Fidelity insurance and annuity products are issued by Fidelity Investments Life Insurance Company (“FILI”), 900 Salem Street, Smithfield, RI 02917 and, in New York, by Empire Fidelity Investments Life Insurance Company® (“EFILI”), New York, N.Y. FILI is licensed in all states except New York; EFILI is licensed only in New York. Fidelity Insurance Agency, Inc. and, in the case of variable annuities, Fidelity Brokerage Services, Member NYSE, SIPC, are the distributors. A contract's financial guarantees are subject to the claims-paying ability of the issuing insurance company.

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