Tax-Exempt Bonds and Funds Ease the IRS Bite

The government has its eye on recouping some of the tax money it loses on tax-exempt investments issued by state and local governments.

Already the government has begun to meddle with the tax-exempt status of these investments by requiring their inclusion in calculating total income declared by taxpayers who are receiving Social Security retirement benefits.

This government intrusion into the green pastures of tax-exempt income comes at a time when more and more investors are finding out just how nice tax avoidance really is.

Benefits for Many

“Tax-exempt investments,” according to Alexandra Armstrong, a nationally known financial planner, “used to be the domain of the very rich.” Now, she says, “people with moderate incomes can enjoy the benefits of tax-exempt status.”

Tax-exempt bonds, bond funds and money market funds all pay a lower interest rate than equivalent, taxable investments. This benefit was given to states, cities and other public money-raisers to cut their borrowing costs.

While a regular money market fund might pay 9% today, a tax-exempt money market fund might pay 6%. But, when taxes are accounted for, it can make the tax-exempt investment, in effect, pay out 10% to 12%.

In general, says financial expert Armstrong, “the break-even point is the 30% tax bracket.” This means that a married couple, filing jointly, with taxable income of $30,000 or more, could benefit from tax-exempt investments. A single taxpayer would have to earn more than $36,000 a year.

With a tax-exempt money-market fund, like any money-market fund, you put money in and take it out any time you like without any penalties or restrictions. You never lose any of your original investment. Interest rates are calculated as the market goes up or down and your return on your money will vary from week to week. Current tax-exempt rates are now running close to 6%.

Not Counted for Taxes

And, unless you are a Social Security beneficiary, you don’t have to include income from these investments when you tote up your tax bill.

Some funds even give you exemptions from state and local taxes that can boost your overall taxable income equivalent to 14%-plus.

There are now some tax-exempt money market funds available for New York State (New York City dwellers are exempt from local taxes too), Massachusetts and California. Funds for other states are on the way.

If you want to get a higher tax-exempt yield on your investment, you have to buy a regular tax-exempt bond fund. These funds, like regular bond funds, pay more but there’s more of a risk. Right now regular, tax-exempt bond funds are paying around 9%.

The funds do not promise to redeem your shares for what you paid for them, as do the money market funds. You might get back less than you put in--or more--depending on what the market is doing.

Where do you find tax-exempt money market funds and tax-exempt regular bond funds? Stock brokers and financial planners sell them as investment tools for their clients. And, you can get a list of fund names and addresses from the Investment Company Institute, 1600 M Street, N.W., Washington, D.C. 20036.