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  1. #1

    Any reason for muni bonds in 15% tax

    My wife and inherited a sum of money last fall, which we are undecided about in terms of long term investing. I had the bad timing to invest a portion of it in two Fidelity muni funds, which dropped considerably after the election. I'm new to muni funds and was surprised by their performance, and should have done my homework better.
    Most of the money we inherited is still sitting in our money market account, earning a whopping 1% interest. I've been researching other investment options and it seems that in our tax bracket (15%), we would probably be better off investing in taxable bond funds. There seem to be plenty of taxable funds with higher yields, more diversification and less interest rate risk than munis. Is there any reason to even consider munis at our tax rate?
    We are both retired with most income needs met by our pensions, and our retirement savings are 60/40 stocks/bonds. No need to invest the inheritance in stocks, so prefer to keep it reasonably safe, but no immediate or short term need to spend it.

  2. #2
    Yes to keep taxable income in the 15% bracket where qualified dividends and LT cap gains are taxed at 0%. Once taxable income (not AGI) exceeds 75.9k for a married couple there are two separate tax rates that apply. First LT cap gains and qual dividends will be taxed at 15% to the extent that taxable income exceeds 75.9K. Second, the additional ordinary income (e.g., taxable bond interest) which replaces the tax exempt muni bond interest will also be taxed at 15%.
    Example: married couple with $75.9k taxable income including 10k of qualified dividends and 10k of interest from muni bonds is only taxed on 65.9k of income because qualified dividends and muni bonds are taxed at 0%. If the 10k muni bond income is replaced with 10k of taxable bond interest, the taxable income increases to $85.9k which results in 1.5k in taxes on the 10k of qualified dividends and an additional 1.5K of income tax on the 10k of taxable bond interest.
    Total tax increase due to substitution of taxable bonds for muni bonds is 3k.

  3. #3
    Yes to keep taxable income in the 15% bracket where qualified dividends and LT cap gains are taxed at 0%.
    Exactly .... the decision to use Munis versus Taxable Bonds is not just about the differential rate.

  4. #4
    Have you considered your likely tax bracket AFTER you've invested the inheritance in taxable fixed income products? And after forthcoming RMDs, if any? If you're still in 15% bracket then, I'd personally stick with higher yielding taxable products --- but it would never hurt to pay for a couple hours of fee-only advisor time

  5. #5
    You also might want to use Taxcaster, available free from Turbotax, to estimate your taxes. I use it rather than rely on our tax accountant. It's pretty accurate if you have a handle on your income and deductions.

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