Rising interest rates They have revived American interest in fixed income investments such as bonds Money market fundBut experts warn that they should be prepared for taxes.
To fight inflationThe Federal Reserve raised its benchmark, short-term interest rate, to 5.25%-5.50%. near zero At the beginning of 2022 and into the year The highest level in 22 years.
Higher rates hurt savers who have to pay more to borrow but savers who get higher returns on their money, especially when the economy is uncertain and the stock market is volatile. Money market fund assets, for example, grew to record highs 5.69 trillion dollars Fed data for the first three months of this year shows.
That is high, stable and It is almost harmless. Income can come with a price: Come the new year, you could find yourself with a big tax bill, experts say.
“On the one hand, it’s great news, you’re getting high interest, but are you prepared to take a tax hit if you have to make the estimated payment in April or sooner?” said Rob Keller, tax partner at tax advisory firm KPMG.
What are fixed income investments?
Fixed income assets are those with regular, steady payments, such as savings accounts. Money market fund, Certificates of Deposit (CDs), or government and municipal bonds. They are generally low risk income earners.
In a balanced portfolio, they are used to offset stock holdings, which are risky and typically generate income through appreciation. A traditional balanced portfolio consists of 60% stocks and 40% fixed income 60/40 portfolio.
How are fixed income investments taxed compared to stocks?
Funds generated from fixed income assets are considered income and taxed at your income tax rate, whichever bracket you fall into. In 2023, the IRS lists Seven federal income tax rates It ranges from 10% to 37%.
In St. Louis, Mo.
Qualified stock dividends and capital gains tax rates of assets held for at least one year 0% to 20%, such as tax income and application status. Most people pay 15% capital gains tax when they sell their shares. The IRS says.
Fixed income payments may be subject to state tax. This can be especially bad if you live in a high income tax state like California or New York, both of which have top rates of more than 10%, consultants said.
“If you are in a higher tax bracket, 50% of your interest income goes back to the government,” Qureshi said. “On the surface, 5.5% interest on your money sounds good, but if you have to pay half of it back, it’s not so good.”
Is there a way to reduce the tax deduction?
Yes, think about what you are buying and where you are keeping the assets.
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If you invest in a U.S. government-backed security, such as a T-bill, note, or bond, you can avoid state taxes.
“You still pay federal taxes on the interest income, but if you live in a high-tax state like California, a T-bill can be a great investment because you can save on the home state,” Keller said.
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They are municipal bonds issued by state, city and local governments. Generally exempt from federal taxas well as. In addition, the bonds are often exempt from state tax in the state in which they are issued, but there are exceptions, so advisors should tread carefully and check with an advisor about the municipal bond laws they are considering.
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Invest in fixed income assets using non-deductible retirement accounts. This is not only to skip taxes now, but control They want to withdraw the money and pay taxes, said JR Gondek, managing director and partner at Lerner Group, a wealth management firm.
Vulnerability to: The best low risk investments of 2023
Are fixed income investments worth considering the tax implications?
Yes. Even if there’s a tax problem, advisers say you can still come out ahead, even if it’s not as much as you’d hoped.
“Even though you’re paying taxes, you’re still making money,” Keller said. He also said, “For many taxpayers, 5.5% interest is good. Not all taxpayers pay the top marginal (income tax) rate and would probably live with no (income) tax at all, like in Texas.
What else should I know about fixed income investments?
Not every fixed income property is the same so you need to do your homework. example:
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Treasurys are very safe Because first, they are 100% guaranteed by Uncle Sam so you can always get your investment back, but money market funds are neither guaranteed nor FDIC insured, which means you can lose your entire investment. Money market accounts and CDs, however, are FDIC insured up to $250,000.
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Municipal bonds If you want to dispose of them, they are not as easy to sell as Treasuries because they are issued in very small amounts.
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While CDs They are easy to buy Treasuries – Treasuries must be purchased directly from the government, but CDs can be purchased through banks, credit unions, and brokers – CDs require close management. The amount you lock for a CD is only for the duration of the CD. If the CD is automatically copied, it may do so at a slower speed. Or there may be fees if you withdraw early. There are no fees for cash withdrawals.
Medora Lee is a money, markets and personal finance reporter for USA Today. You can find her on [email protected] And subscribe to our Daily Money newsletter every Monday for personal finance tips and business news.
This article originally appeared on USA TODAY: High interest rates boost fixed income investments, but beware of taxes!
