Wink Tax Services
IN THIS ISSUE . . .
Whether you’re just starting to invest in municipal bonds or are reviewing your current portfolio of municipal bonds, you should consider the following guidelines:
If you’d like assistance with your municipal bond portfolio, please call us at (800) 878-4036.FROM YOUR 401(K) PLAN?
Approximately 65% of all 401(k) plans offer loan provisions to participants. While loan procedures and terms will vary by plan, general federal regulations regarding 401(k) loans include:
While borrowing from your 401(k) plan is a convenient way to obtain money, it is important to consider a couple of factors before doing so. Although the interest rates charged on 401(k) plan loans are generally attractive, keep in mind that you are foregoing investment growth on the outstanding principal. The attractive interest rates may seem very expensive if you miss a major rally in your 401(k) investments.
Make sure that you can easily repay the loan. You don’t want to be forced to reduce or eliminate new 401(k) contributions because you are struggling to repay your loan balance.
If you have a equity in your home, consider a home-equity loan instead of a 401(k) loan. Interest rates on home-equity loans tend to be comparable to interest rates on 401(k) plan loans and the interest paid on the home-equity loan is usually deductible on your tax return if the loan balance is less than $100,000. Since interest paid on a 401(k) plan loan is not deductible on your tax return, a home-equity loan may have a lower after-tax cost than a 401(k) plan loan.
If you’d like to discuss whether you should obtain a loan from your 401(k) plan, please feel free to call at (800) 878-4036.TAXABLE EQUIVALENT RATES
Before investing in tax-exempt bonds, you should compare the yield to the yield you could obtain on a taxable investment with a similar maturity and credit rating. In order to do that, you need to convert the tax-exempt rate to a "taxable equivalent." If you’re not investing in a municipal bond issued within your own state, which also exempts income from state and sometimes local taxes, the calculation is fairly straightforward: the taxable equivalent equals the tax exempt interest percentage divided by 1 minus your marginal tax bracket: Tax-exempt interest % = Taxable
(1-marginal tax bracket) equiv. %
For example, municipal bonds, as measured by the Bond Buyer Municipal Bond Index, currently yield 5.83% (Source: Barron’s, August 12, 1996). If you’re in a 28% tax bracket, you’d need a taxable investment with a yield greater than 8.10% to outperform the tax-exempt bond [5.83/(1-.28)=8.10]. (This example is included for illustrative purposes only and is not intended to project the future performance of any specific investment vehicle.)
The table below will give you a general idea of taxable equivalent percentages for various tax-exempt yields and tax brackets.
Marginal tax rate 15% 28% 31% 36% 39.6%
Married filing jointly $0-40,100 $40,100-96,900 $96,900-147,700 $147,700-263,750 over$263,750separately 0-20,050 20,050-48,450 48,450- 73,850 73,850-131,875 over 131,875
Head of household 0-32,150 32,150-83,050 83,050-134,500 134,500-263,750 over 263,750
Tax-exempt yields (%) Taxable equivalent (%)
3.50 4.12 4.86 5.07 5.47 5.79
4.00 4.71 5.56 5.80 6.25 6.62
4.50 5.29 6.25 6.52 7.03 7.45
5.00 5.88 6.94 7.25 7.81 8.28
5.50 6.47 7.64 7.97 8.59 9.11
6.00 7.06 8.33 8.70 9.38 9.93
6.50 7.65 9.03 9.42 10.16 10.76
7.00 8.24 9.72 10.14 10.94 11.59
Municipal bonds have been having a tough time lately. First, repercussions from the Orange County bankruptcy caused many investors to approach municipal bonds more cautiously. Then, a rocketing stock market caused many investors to concentrate on the stock market, ignoring municipal bonds. Finally, talk about a flat tax, which would reduce much of the appeal of municipal bonds, has made many nervous about purchasing municipal bonds.
The allure of municipal bonds is that in most cases their income is exempt from federal income taxes and, if the bonds are issued the state you reside in, also from state and local income taxes. Thus, the higher your marginal federal income tax rate, the more valuable this tax-exemption becomes. Someone in the 39.6% tax bracket will find a municipal bond more advantageous than someone in the 15% tax bracket. But if a flat tax of 17% is enacted, then this tax advantage becomes less important since everyone is paying the same tax rate.
Yet even though the flat tax is not even close to being enacted, the differences between returns on municipal bonds, 30-year treasury bonds, and corporate bonds have narrowed significantly. In fact, many feel that municipal bonds are being priced as if the new rate was already in effect. For example, municipal bonds were recently yielding 5.83% as measured by the Bond Buyer Municipal Bond Index, an unmanaged index of 40 actively traded tax-exempt bonds. For comparison purposes, 30-year treasuries yielded 6.94% and corporate bonds, as measured by the Dow Jones Bond Average, yielded 7.21% (Source: Barron’s, August 12, 1996). At a 16% tax rate, the yield on the municipal bond is equivalent to the yield on the 30-year treasuries. Anyone in a higher tax bracket would earn more on an after-tax basis with municipal bonds. At a 19% tax rate, the yield on a municipal bond is equivalent to the yield on corporate bonds.
Thus, if the flat tax is enacted, investors will still earn a return comparable to 30-year treasuries and corporate bonds. But, if the flat tax is not enacted, municipal bond investors will receive a return higher than that. In the 15% tax bracket, the 5.83% municipal bond yield is equivalent to a taxable yield of 6.86%; in the 28% tax bracket, 8.10%; in the 31% tax bracket, 8.45%; in the 36% tax bracket, 9.11%; and in the 39.6% tax bracket, 9.65%. (This example is included for illustrative purposes only and is not intended to project the performance of any specific investment alternative.)
Although municipal bonds aren’t an attractive investment for everyone, they also shouldn’t be shunned totally because of talk about the flat tax. If you’d like to discuss whether municipal bonds make sense for your situation, please call us at (800) 878-4036.
KEEPING YOUR RECORDS IN ONE PLACE
Answer truthfully: if something happened to you today, would your heirs be able to readily locate all important financial information? If you’re like most people, your records are probably scattered in a number of places and you’re the only one who knows how to find all pertinent information. Not only will this make it difficult for your heirs to settle your financial matters, it will also make it difficult for them to be sure they’ve identified all your assets and liabilities.
Although organizing records is never a fun task, keeping all this information organized in one place will help your heirs identify your assets and liabilities and inform them of professionals that handle your affairs, such as lawyers, accountants, and financial advisers. It may also serve some immediate purposes, such as helping you assess your current financial situation, making you reevaluate your investments, causing you to think about your estate plan, or reviewing the adequacy of your insurance policies.
You’ll want to gather and record details about: wills; safe deposit boxes; life insurance policies; hospital, medical, and disability insurance; homeowner’s insurance; employee savings and stock plans, individual retirement accounts; credit cards; income tax records; real estate records; outstanding debts; children’s accounts and trusts; savings accounts; investments; and financial advisers. Many of these records you won’t want to keep at home, but you should indicate where the original documents are located. Be sure to indicate where birth, marriage, and military records are located since these documents are often needed to collect death benefits.
Once you complete this record, keep it in a safe place at home and make a copy for your safe-deposit box. Make sure your family knows where the record is located and be sure to update it on at least an annual basis. If you’d like help with this process, please call us at (800) 878-4036.
Tax Disclaimer: To ensure compliance with IRS Rules, any U.S. federal tax advice provided in this communication is not intended or written to be used, and it cannot be used by the recipient or any other taxpayer (i) for the purpose of avoiding tax penalties that may be imposed on the recipient or any other taxpayer under the Internal Revenue Code, or (ii) in promoting, marketing or recommending to another party a partnership or other entity, investment plan, arrangement or other transaction addressed herein.
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Wink Tax Services / Wink Inc.