AskDong

Friday night, and I’m writing my blog. Clearly I need to get a life. Actually it’s nice to treat to stay in sometimes. Anyhow, I wanted to get back to my commentary on Investment and Taxes. I’ve already outlined the tax features of the different types of holding accounts. I’m an enourmous fan of the Roth IRA account, and truly do believe it’s the best available account there is. Max it out it if you can. I know some people might argue that other tax deductible accounts offer a better advantage for individuals in higher tax brackets. However, my argument is that we’re at historically low tax rates for high income individuals. Tax rates can (and in my opinion should) go up. I’ll save my arguments for potentially higher taxes for another more political entry as they are not relevant for this discussion.

Investments can basically be broken into two basic categories - income generating and non-income generating. Bonds, Bond Funds, REITs, dividend paying stocks and stock funds are income generating. “Growth” Stocks and funds are generally non income generating. Ideally all income generating assets should be placed in tax deferred accounts to avoid getting a tax bite taken out every year. Non-income generating investments are by their nature like a deferred tax investment, and therefore do not need to be further sheltered within a deferred tax account. The one other thing is the tax treatment of Government issued bonds. Federal bonds are exempt from State and Local taxes. Municipal (State and Local) are exempt from federal taxes and local taxes (if held by a resident). The special tax privileges of government issues should be taken into consideration. There is absolutely no reason for municipal bonds to be held in anything but a taxable account as there are no taxes to avoid or defer. Do not ever hold a municipal bonds funds in either an IRA or some type of annuity. It really does happen if you’re not careful.

Below is a quick little table of how I rate suitable holding account as related to a particular kind of asset.

You can see my love for the Roth. Obviously if you could (and you weren’t worried about immediate needs) you would put everything into a Roth IRA, but you can’t, and that’s what the other holding accounts are for. As I see it maximize your options in all the tax deferred accounts and then look to the taxable brokerage account. The one exception is Growth Stocks (non dividend paying stocks really) in which you would be trading lower long term capital gains for higher income tax rates by placing them in tax deferred account.  The other thing to note is that this is a table about future tax implications, not current implications. i.e. I’m not saying you should put money into a taxable growth fund before you put money into your 401k. By all means take advantage of the current tax break. But once the monies are in the accounts, you should ask what you should be investing in.  That’s what this table is intended for.

The one other thing to keep in mind is that municipal bonds can fall under two different categories - General Obligation and Revenue Bonds. Revenue Bonds are not exempt from AMT. As a result if you’re ensnared or in danger on being snared by AMT, try to keep your municipal investments in General Obligations. Many municipal funds are structured for this, so if you’re a careful investor, this should not be a problem.