Last week I addressed tax-efficiency in your portfolios. Here I shall review the differences among those classifications of taxable, tax-deferred and tax-exempt to make tax-efficiency more readily understood. The following are simple explanations. For expert tax guidance please speak with your accountant or tax attorney.
Taxable: an account that holds money on which you have already paid taxes - e.g. bank checking or savings accounts or brokerage accounts. These accounts may have stocks, bonds, CD's, etc. Every year you receive a 1099 of all reportable earnings: dividends and interest as well as reportable proceeds: stock or bond sales. You enter these numbers on your tax return and pay taxes accordingly.
Tax-exempt: refers to bonds (loans) issued by municipalities (states, cities, towns, counties). These bonds are exempt from federal taxes. As an incentive to its residents to buy these bonds, which finance local projects, you pay no state taxes on the interest. As a NY resident, if you purchase a NY State bond, it will be double tax exempt as you will pay no state or federal taxes on the interest. However, NY reserves the right to tax the interest earned on other states' bonds.
Tax-deferred: means you pay no taxes now but when you withdraw the money both state and federal taxes are due. IRA, SEP, 401k, 403b all grow tax-deferred. Your 401k or 403b plan from work will take money from your paycheck before deducting taxes, deposit the money into your plan where it will grow tax-deferred (you will not receive a 1099 each year). Taxes will be paid when you start withdrawing money from these accounts later in retirement. The money will be taxed, as your income is taxed, both by the state and the federal government. Hopefully, in retirement you will be in a lower tax bracket and, consequently, pay less in taxes.
Tax-free: refers to a Roth IRA where money grows without paying taxes each year and is distributed without being taxed. Actually, the money contributed to most Roth IRA's is money on which you have already paid taxes; it is the earnings (growth) that are tax-free.
Be $ Smart - Learn about the impact of taxes on your investments. Position your assets effectively to pay less in taxes.
Showing posts with label municipalities. Show all posts
Showing posts with label municipalities. Show all posts
Sunday, April 15, 2018
Tuesday, April 14, 2015
Investment Diversification cont'd - Bonds
When you talk about diversification you hope to spread your money into a variety of investments. By doing so, you are given the opportunity to create the potential for your money to grow while you reduce the risk.
Last week we addressed stocks. This week we'll review the many facets of bonds.
Bonds come in many varieties - both taxable and tax exempt.
With a bond, you are lending your money; it may be to a corporation, a country or a municipality.
Corporate bonds are issued by companies, of all sizes. High grade corporate bonds from major corporations carry high ratings and the interest earned and distributed is taxable. Most high rated bonds are backed by collateral, e.g. inventory, buildings, property, machinery, etc. Because of their relative safety, they will pay a lower interest rate.
High yield corporate bonds pay a higher return because they may be less safe. The company may be having some financial difficulty and the bonds may be backed by a "promise to pay", not real collateral.
Governments issue bonds for many reasons to run their country. Our own U.S. Treasury offers several types of bonds. Sovereign bonds issued by governments outside the U.S. offer international diversification. Because of the solvency of each country, the risk and yield (return) will vary. You will pay taxes on the interest you earn on these bonds.
Municipalities like cities, states, counties, towns all have the ability to borrow money and issue bonds. Again, the solvency of the region will determine how safe your money may be and the interest each will pay. There are several agencies that rate these bonds. AAA is the highest all the way on down to NR, not rated. The U.S. government does not tax the income from these bonds - they are considered tax-exempt.
A bond issued by New York city would be triple tax-exempt to a resident of NYC. He would pay no city, state or federal tax on that bond.
For diversification you would want some taxable and tax exempt bonds.
You would use bonds of different countries as well as different municipalities.
Be $ Smart - use several different types of bonds when building a portfolio.
Bonds can be quite complex. This is a simplified overview.
Last week we addressed stocks. This week we'll review the many facets of bonds.
Bonds come in many varieties - both taxable and tax exempt.
With a bond, you are lending your money; it may be to a corporation, a country or a municipality.
Corporate bonds are issued by companies, of all sizes. High grade corporate bonds from major corporations carry high ratings and the interest earned and distributed is taxable. Most high rated bonds are backed by collateral, e.g. inventory, buildings, property, machinery, etc. Because of their relative safety, they will pay a lower interest rate.
High yield corporate bonds pay a higher return because they may be less safe. The company may be having some financial difficulty and the bonds may be backed by a "promise to pay", not real collateral.
Governments issue bonds for many reasons to run their country. Our own U.S. Treasury offers several types of bonds. Sovereign bonds issued by governments outside the U.S. offer international diversification. Because of the solvency of each country, the risk and yield (return) will vary. You will pay taxes on the interest you earn on these bonds.
Municipalities like cities, states, counties, towns all have the ability to borrow money and issue bonds. Again, the solvency of the region will determine how safe your money may be and the interest each will pay. There are several agencies that rate these bonds. AAA is the highest all the way on down to NR, not rated. The U.S. government does not tax the income from these bonds - they are considered tax-exempt.
A bond issued by New York city would be triple tax-exempt to a resident of NYC. He would pay no city, state or federal tax on that bond.
For diversification you would want some taxable and tax exempt bonds.
You would use bonds of different countries as well as different municipalities.
Be $ Smart - use several different types of bonds when building a portfolio.
Bonds can be quite complex. This is a simplified overview.
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