Question About a Tax Free Income Fund?

Question

I've always wondered this... What are the advantages of a tax free income fund. I know you aren't taxed on your gains until you actually take out the money.. but what I don't know what does this mean in percentage points. How much additional money percentage wise do you gain yearly in a tax free fund. The return sucks, so I want to know how much % to add to stated return.

Answer 1

Obviously, this is going to depend on your tax rate.  As a general rule, if your federal tax bracket is 15% or less, tax-exempt investments are not worth the lower rates.

Answer 2

If it is federal tax exempt, there is no federal tax period (except possibly subject to AMT).  To see if the lower return is worth it, look at your marginal tax rate and deduct that percentage from a similar taxable investment return to see how it compares.

Just for a rough example, last year a taxable money market might have paid 5% and fed tax free MM might have paid 3.5%.  So if your marginal tax bracket was 30% or more (or you just did not want to bother with estimated tax) the non-taxable might make sense.  Now with the taxable paying 2.41% and non-taxable 1.29% the taxable would likely make more sense.

Of course you also need to consider state tax.  Some funds are also state tax free just in specific states.  Or some funds may be more or less favorable if subject to AMT.

Answer 3

It depends on your own total annual income and filing status. For example, if you are in the 15% Federal tax bracket, it would be the equivalent of saving 15% of the income of the fund. More if the fund is also state and local tax-free.