Is There Such a Thing as a Tax-Free Investment?

The simple answer to this question is “yes.” There are two main types: (1) municipal bonds and municipal bond mutual funds and (2) tax-free money market funds.

Municipal bonds are issued by state and local governments in order to finance capital expenditures; typically, municipal bond funds invest in municipal bonds. Municipal bonds are typically free of federal tax because the interest generated by bonds issued by a state, municipality, or other local entity is exempt from federal taxation.

As an added benefit, most states will allow a state tax exemption if the owner of the bond resides in the state of issue. However, if you purchase a bond outside your area of residency, it may be subject to both state and local taxes.

If you buy shares of a municipal bond fund that invests in bonds issued by other states, you will have to pay income tax. In addition, while some municipal bonds that are in the fund may not be subject to ordinary income tax, they may be subject to federal, state, or local alternative minimum tax. If you sell a tax-exempt bond fund at a profit, there are capital gains taxes to consider. Bond funds are subject to the same inflation, interest-rate, and credit risks associated with their underlying bonds. As interest rates rise, bond prices typically fall, which can adversely affect a bond fund's performance.

Municipal bonds come in a variety of forms and should be selected by strict criteria based predominantly on the state’s or municipality’s ability to service the debt. It’s important to remember that the principal value of bonds may fluctuate with market conditions. Bonds redeemed prior to maturity may be worth more or less than their original cost. Investments seeking to achieve higher yields also involve a higher degree of risk.

Tax-free money market funds invest in short-term note of state and local governments and can provide a high amount of liquidity. Money market funds can be invested in a wide range of securities, so it is important to analyze your options carefully before investing.

Money market funds are not insured nor guaranteed by the Federal Deposit Insurance Corporation (FDIC) or any other government agency. Although money market funds attempt to preserve the value of your investment at $1.00 per share, it is possible to lose money by investing in such a fund.

If you decide to invest in either type of tax-exempt security, consider the different options carefully. You can purchase individual bonds, which come in denominations of $1,000. Or you might consider investing in a municipal bond mutual fund, a portfolio of bonds in which you can invest for as little as $500. Municipal bonds can also be purchased through a unit investment trust, a closed-end portfolio of bonds with minimums of $1,000.

Often tax-exempt securities are the most favorable for those in higher tax brackets, so it’s important to determine whether buying them would be an advantageous move for you. To decide whether municipal bonds or money market funds would be an asset to your portfolio, calculate the taxable equivalent yield, which enables you to compare the expected yield of the tax-exempt investment with its taxable equivalent.

For instance, if you are in the 28% marginal income tax bracket and invest in a municipal bond yielding 5%, this is equivalent to investing in a taxable investment yielding 6.94%. If you are in the 35% tax bracket and invest in the same bond, it would be the equivalent of investing in a taxable investment yielding 7.69%.

Also, be aware that tax-exempt income is included in the formula for determining taxes on Social Security benefits. In some instances, it may be necessary to limit your tax-exempt income by shifting to other tax-advantaged investment areas.

If they’re in-line with your investment objectives, tax-exempt securities can be an excellent means of reducing taxable income. Check your options with your tax advisor.

Mutual funds are sold by prospectus. Please consider the investment objectives, risks, charges, and expenses carefully before investing. The prospectus, which contains this and other information about the investment company, can be obtained from your financial professional. Be sure to read the prospectus carefully before deciding whether to invest.

The information in this article is not intended to be tax or legal advice, and it may not be relied on for the purpose of avoiding any federal tax penalties. You are encouraged to seek tax or legal advice from an independent professional advisor. The content is derived from sources believed to be accurate. Neither the information presented nor any opinion expressed constitutes a solicitation for the purchase or sale of any security. This material was written and prepared by Emerald. © 2012 Emerald Connect, Inc.
Custom Portfolio Management-Caruso McLean Investment Advisors
110 Lomond Court • Utica, NY • 13502
Phone:
315.724.5105
877.724.5105 		• Fax:
315.724.5196
• info@carusomclean.com

Securities offered through Royal Alliance Associates, Inc. member FINRA/SIPC.www.finra.org

 
   DISCLOSURES

Gregory B. McLean, Stephen L. Caruso, Mark Steckler and Lori A. Glennon are Registered Representatives of and offer securities products & services through Royal Alliance Associates, Inc. Member FINRA/SIPC, a registered broker dealer. In this regard, this communication is strictly intended for individuals residing in the states of Arizona, Connecticut, Florida, Georgia, Indiana, Massachusetts, New Hampshire, New Jersey, New York, North Carolina, Ohio, Pennsylvania, South Carolina, Texas, and Virginia. No offers may be made or accepted from any resident outside the specific states referenced.

Gregory B. McLean,  Stephen L. Caruso and Lori A. Glennon are also separately registered as investment adviser representatives under Caruso McLean & Co., Inc., a registered investment advisor, offering advisory services in the state of New York. As such, these services are strictly intended for individuals residing in New York.

IMPORTANT CONSUMER INFORMATION:
A broker-dealer "BD", investment adviser "IA", a BD agent, or IA Representative may only transact business in a state if first registered in that state, or is excluded or exempt from registration in that state as a broker-dealer, investment adviser, BD agent or IA Representative, as appropriate. Follow-up, individualized responses to persons in a state by such firm or individual that involve either affecting or attempting to affect transactions in securities, or the rendering of personalized investment advice for compensation, will not be made without first complying with appropriate registration requirements, or an applicable exemption or exclusion.

For information concerning the licensing status or disciplinary history of a broker-dealer, investment adviser, BD agent, or IA rep, a consumer should contact his or her state securities law administrator.

HYPERLINK DISCLAIMER:
All link information being provided is strictly as courtesy. When you link to any of the websites provided herewith, you are leaving this site. Caruso McLean & Co., Inc. and Royal Alliance Associates, Inc. make no representation as to the completeness or accuracy of information that is provided at these sites. Nor are the companies liable for any direct or indirect technical or system issues or any consequences arising out of your access to or your uses of third-party technologies, sites, information and programs made available through this site.

You are now leaving the website of Caruso McLean & Co., Inc. and you assume total responsibility for your use of the sites you are linking to.

The views expressed are not necessarily the opinion of Royal Alliance Associates Inc, and should not be construed directly or indirectly, as an offer to buy or sell any securities mentioned herein. Individual circumstances vary.

All Investing involves risk including the potential loss of principal. No investment strategy such as asset allocation can guarantee a profit or protect against loss in periods of declining values. Past performance is no guarantee of future results. Therefore, the information presented here should only be relied upon when coordinated with individual professional advice.

Periodic investment plans such as dollar cost averaging do not assure a profit or protect against a loss in declining markets. Such plans involve continuous investment in securities regardless of fluctuating price levels. Investors should consider their financial ability to continue purchases through periods of low price levels.

Indexes cannot be invested in directly, are unmanaged and do not incur management fees, costs and expenses

Fixed income investments are subject to various risks including changes in interest rates, credit quality, inflation risk, market valuations, prepayments, corporate events, tax ramifications and other factors. Securities sold or redeemed prior to maturity may be subject to a substantial gain or loss. In general, the bond market is volatile as prices rise when interest rates fall and vice versa. Vehicles that invest in lower-rated debt securities (commonly referred to as junk bonds) involve additional risks because of the lower credit quality of the securities in the portfolio. The investor should be aware of the possible higher level of volatility, and increased risk of default.

International investing involves special risks not present with U.S. investments due to factors such as increased volatility, currency fluctuation, and differences in auditing and other financial standards. These risks can be accentuated in emerging markets.