The Benefit of Municipal Investing For many income-oriented investors, it's not what they earn that's important…it's what they keep. With municipal investments, the income you earn is generally exempt from federal income tax. So you keep more of what you earn. Even if you're taxed at a lower rate, the difference in income can be substantial when taxes don't take a bite out of your earnings.
How Do You Determine Whether Municipal Investing
Is Right for You?
There are several factors you should consider when choosing a taxable OR
tax-exempt income investment, like the time horizon for your investment, and
your tolerance for risk. The higher the level of income you want to pursue,
the greater level of price fluctuation you should be prepared to tolerate. Consider
long-term investments or longer-term average maturity funds – which tend
to have greater price fluctuation – for longer-term goals.
The decision between whether a taxable or tax-exempt bond or bond fund is
right for you can be made in part by comparing the yields. Since the yields of municipal
investments and your tax rate may change over time, you should constantly reevaluate
the benefits of municipal investments in your portfolio. To discover how a taxable
and tax-free yield compare, use the following formula:
The calculator below allows you to convert a federally tax-exempt yield into a taxable equivalent – therefore you can compare apples to apples.
Take a Look at the Following Hypothetical Example
Yield |
Taxable Equivalent Yield (in the 35% federal income tax bracket) |
|
|---|---|---|
| Taxable money market fund | 1.50% | — |
| Federally tax-exempt money market fund | 1.25% | 1.92% |
An investment in a money market fund is not insured or guaranteed by the Federal Deposit Insurance Corporation or any other government agency. Although the fund seeks to preserve the value of your investment at $1.00 per share, it is possible to lose money by investing in a money market fund.
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You keep more of what you earn. For example, you have a $10,000 investment that earns 5% annually. If it is invested in a tax-free investment, you keep all $500 in earnings. In a taxable investment, at a 25% tax rate, you keep $375, paying $125 in taxes. At a 28% tax rate, you keep $360, paying $140 in taxes. At a 33% tax rate, you keep $335, paying $165 in taxes. At a 35% tax rate, you keep $325, paying $175 in taxes.
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