Cents and Sensibility
Cents and Sensibility
Were you one of the millions of Americans who received tax rebate checks last year? If so, how would you like to experience that kind of savings every year? You can by investing in tax-free investments, such as municipal bonds, tax-free unit investment trusts and tax-free mutual funds. Tax-free investments
may be good fitTax-free investments pay interest that is free from federal taxes, so you keep more of the income you earn. That means more money for you to spend as you wish rather than sending it to the IRS.
How do you determine if you can benefit from tax-free investments? It's actually a simple, two-step process. All you need is a copy of your most recent 1040 tax form.
Step 1 >> Read Line 8a on the form. This is how much taxable interest income you earned and paid taxes on. For instance, if you earned $1,000 and were in the 27 percent tax bracket, after paying taxes, you had $730.
Step 2 >> Now, look at Line 8b. This is how much tax-exempt interest income you earned. Although you report this income, you don't pay taxes on it. In other words, if you earned $1,000 in tax-exempt interest income, you kept $1,000.
To put it simply, the more income you can move from Line 8a to Line 8b, the more money you get to keep.
If you've never considered tax-free investments before, you may be discouraged by the seemingly lower rates of returns tax-free investments offer when compared to taxable investments. Don't fall into this trap. Remember, you don't pay taxes on the income from tax-free investments; to get a true comparison of returns, you must examine after-tax returns.
Sound complicated? It's not. All you need is the rates offered by both investments and your current tax bracket. For example, if you're in the 27 percent tax bracket, you would need to earn 6.85 percent on a taxable investment to match the tax-free return of a municipal bond paying just 5 percent.
It's important to note that tax-free mutual funds and unit trusts may be subject to alternative minimum tax as well as state and local taxes. Both will affect your after-tax return, so be sure to ask about this when considering any tax-free investment.
Can you benefit from tax-free investments? If you received a tax rebate check last year, chances are that you can. To confirm this, check your most recent 1040 form and compare Lines 8a and 8b. If you can benefit from moving more income from Line 8a to Line 8b, consult an investment professional to see which tax-free recommendations are best-suited to your individual investment needs and goals.
Guy Steele is a financial planner and head
of the Pali Palms office of Edward Jones. Send
planning and investing questions to him at 970
N. Kalaheo Ave., Suite C-210, Kailua, HI, 96734,
or by email at: gsteele2@pixi.com