How to turn my $1 million into passive income while keeping taxes low?

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I have a million dollars and I want it to work for me. Where can I get the most passive income from it? Also, how to minimize taxes so that more money can be retained?

- Andrea

Although today’s high interest rate environment is challenging in many ways, Silver’s journey is that investors trying to earn passive income can do it easier than they do since the global financial crisis of 2007-2009.

Before coming up with some options to take advantage of the current rate of return and consider the relevant tax consequences, assessing your current financial situation and asking yourself some important questions will help to impact where you put in that money. (Financial advisors can help you both, and this tool can help you match one.)

Investing $1 million to generate passive income is likely the best choice for this money. However, I recommend that you look at this money in the context of a broader financial situation and long-term goals, rather than looking at your decision in a vacuum. In particular, it may be helpful to consider the following:

Your total assets: Do you already have a portfolio? Where are these assets and what are their tax impacts (e.g., IRA, Roth IRA, 401(k), Brokerage account)?
Your working status:How many years will you need to increase your income to increase your assets?
Other income: Do you have other sources of income (Social Security, Pension, etc.)?
Purpose of generating passive income: Have you retired and sought to fund your ongoing expenses? Or provide supplementary revenues while your portfolio continues to grow?
Growth and revenue: Are you willing and/or sacrificing the growth and preservation of purchasing power for your income? If revenue is the only goal or demand, expectations for growth and your ability to maintain the purchasing power of assets should be kept low.

After thinking about these questions, you may pursue other monetary goals. (If you need more help evaluating your financial situation, consider talking to a financial advisor.)

Investors are looking at several options for generating passive income.

Given the rise in interest rates since March 2022, income-oriented assets have become more attractive for those looking to earn a reasonable return from their investment. Building a portfolio that includes a variety of assets that can generate total returns is usually a reasonable approach rather than investing in a single product or security. While financial advisors can help you build a strong portfolio, here are some options:

While generally considered an alternative to holding cash in a savings account, money market funds have become a popular topic among investors due to higher interest rates. Money market yields are close to 0% ahead of a series of recent rate hikes by the Fed, meaning you are effectively not interested in investing. But now, yields are close to 5%, making it a more attractive option to generate low-risk income.

Municipal bonds are another solid choice for income-focused investors. As with any investment, you need to consider your goals before investing in municipal bonds, as risk profiles and income potential vary among securities. Evaluating credit ratings and maturity with the benefits you expect to earn in exchange for credit and duration risk is a necessary step. Since they usually do not pay federal taxes (or state taxes that are issued), municipal bonds are often a tax-effective investment.

Like money market funds, certificates of deposit (CD) are becoming more and more popular as interest rates rise. CDs can be particularly attractive if you don't need to clear your investment within the expected time frame, as you will usually pay a penalty for early withdrawal. Therefore, it is important to keep the CD's maturity date in line with the date you expect to need funds.

If you need some growth to accompany passive income generated by your funds, you may want to consider investing in dividend stocks. As of the end of September, the S&P 500 High Dividend Index had a dividend yield of more than 5%, making it compete with other options listed. Unlike fixed income products, dividend stocks usually provide people with more appreciation opportunities, which may help you maintain your purchasing power if that's a problem.

Of course, there are other options that can generate passive income. These include treasury, high-yield bonds, master's limited partnership (MLP), real estate investment trust (REITS), etc. Before committing to everyone, consider the level of risk you are capable and willing to take, the amount of income you need, and whether there is a need to grow. Also, evaluate the tax impact of the investment you choose. (If you need more help in evaluating and choosing an investment, consider matching with a financial advisor.)

A couple met with financial advisors to address tax mitigation strategies.

For tax purposes, each option quoted above is handled differently. Interest earned on fixed income securities is taxed at the ordinary income tax rate. The tax on dividends is determined by the time you own the assets - eligible dividends are taxed at a long-term capital gains tax rate, while ordinary dividends are taxed at a normal income tax rate. The appreciation of stock securities is taxed at capital interest rates.

It is important to understand the tax treatment of individual assets, as this will play a role in determining the type of account that holds these assets. Generally speaking, an alternative to having a single stock and bond and its passive custody index is more taxable than an actively managed mutual fund. Therefore, it is generally recommended to have a single stock, bond and index funds in a taxable brokerage account. Accounts with tax benefits such as IRAS and 401(k) and after-tax Roth IRAS are often better suited for your actively managed funds and lower tax benefits securities (such as high-yield bonds).

Thinking overall about the assets you own and where to allocate them will ultimately help you mitigate your taxes. Of course, given your specific tax advantages, it may be helpful to talk to your tax advisor to better understand the impact on your personal situation. (Consider matching with a financial advisor with tax expertise.)

Positioning your assets as the generation of passive income is a reasonable strategy, but only if it is aligned with your long-term financial needs and goals. Before committing to this approach, strictly evaluate your personal situation and the basic principles of seeking passive income. From there, you can consider a variety of fixed income products, such as bonds and CDs, as well as stock securities such as dividend payment stocks. Each option has its own tax consequences, and the type of account of the securities held will also have an impact on taxation.

CD ladders are a way to simultaneously generate income by leveraging today’s high interest rate environment. This policy requires opening multiple CD accounts, each with a different expiration date. The idea is that you will always have a CD reaching its maturity date and paying interest. This is the CD price today.

Financial advisors can help you determine which investments are best suited to your financial goals. Finding a financial advisor is not necessarily difficult. SmartAsset's free tools match you with a review financial advisor serving your area, and you can compete with your advisor for free introductory calls to determine which one you think is right for you. If you are ready to find an advisor who can help you achieve your financial goals, get started now.
If you experience unexpected expenses, keep the emergency fund. Emergency funds should be liquid - in accounts that do not have significant fluctuations like stock markets. The trade-off is that inflation can erode the value of liquid cash. However, high interest accounts allow you to earn complex interest. Compare savings accounts for these banks.
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Jeremy Suschak, CFP®, Is a SmartAsset Financial Planning columnist who answers readers’ questions about personal finance topics. Is there a question you want to answer? Send an email to AskAnadvisor@smartasset.com and your questions may be answered in a future column.

Jeremy is a financial advisor and business development director at DBR&Co. The author's other resources can be found in dbroot.com.

Please note that Jeremy is not a participant in the SmartAsset AMP platform, nor is he an employee of SmartAsset, and he has received compensation from this article. For clarity or simplicity, some of the questions raised by readers have been edited.

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