How are municipal bonds taxed?
Tuesday, September 7th, 2010 at
8:01 am
My wife and I are thinking about putting a percentage of our traditional IRA funds into bonds (to introduce a little more stability). I’m concerned though that the we’ll be taxed on bond investments now even though we have a traditional IRA account. Can someone please elaborate on the tax situation here? I’ve heard that municipal bonds may be better if bought from the same state we live in.
Ideally, I’d like to invest in bonds but would like the investment to remain tax-deferred (just like the other stuff in our traditional IRA).
Filed under: Retirement Planning
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Rule #1) Never put Municipal Bonds in a Retirement Account.
Rule #2) When in doubt, refer to Rule #1.
Interest from Municipal Bonds is exempt from Federal taxation and may be exempt from state taxation. They would lose their exempt nature if put in to an IRA.
If you invest in Municipal Bonds, do it in an after-tax account.
State rules vary but, in most states I believe, Municipal Bonds from your home state are exempt from state taxes also.
Note: The above rules also apply to Municipal Bond funds that many fund families offer.
The other post is correct–why make tax exempt interest taxable.
If you buy some munis outside of an IRA, keep in mind that the interest is tax exempt. At sale/redemption the gain, loss and market discount are *not* tax exempt.
Dear M: No muni’s in an IRA does not make sense. Consider a city bond (if you live in a big city) triple tax exempt federal, state and city.
You don’t want to invest in munis within a retirement account. The "tax free" advantage of munis is lost there. Look at investment-grade (taxable) bonds or treasuries for retirement accounts.
The interest paid on muni bonds are not subject to federal income tax and are not subject to state income tax from the state they are issued from so if you want to buy munis, buy local. Yes they are tax free but their is a built in tax in the form of a lower yield. If your marginal tax rate is 25%, a taxable bond yielding 4% is the same as a muni yielding 3%. If you sold one for a profit, that would be subject to tax at capital gains rate.