If the income on Tbills is taxed as interest, not dividends, then it does not qualify for the 15% rate (unless one is in the 15% bracket). Is this correct?So is it better to NOT purchase individual Tbills, and use a bond fund instead, because this is taxed at the dividend rate of 15% ?? We are in the 28% tax bracket, and in the 9.3% state income tax bracket. I had been moving into Tbills because they are exempt from state tax. However, now I am wondering if this is a big mistake.
So is it better to NOT purchase individual Tbills, and use a bond fund instead, because this is taxed at the dividend rate of 15%No, bond funds are taxed at your full rate too. They are "dividends" because they come from a fund, but they are non-qualified dividends, which in this case is just another way to say interest.
I had been moving into Tbills because they are exempt from state tax. However, now I am wondering if this is a big mistake. Folks in high tax brackets usually hold T-bills and bonds in their tax-deferred accounts (i.e. IRAs) to defer the tax liability on the non-qualified dividends until withdrawal. However, the tax liability is only deferred, so if you think you'll be in the same tax bracket when you withdraw, the only thing you've gained is the use of the tax liability dollars during the period of time you didn't pay tax on the dividends. That can still be a substantial savings if you're not going to withdraw for a long time, provided ordinary income tax rates aren't higher when you actually do.As a general rule, bonds, bond funds, and REIT funds should be held in tax-deferred acounts.2old
In the tax brackets you mention, you might want to look at tax free munibonds and bond funds. Many are available that are also state tax free.Most people find that you can get 5 to 6% tax free yield which is equivalent to 9% or better in a taxable bond. But usually the tax free bond is lower risk.Capital gains especially from equities and their dividends offer you lower tax rates. But for fixed incomes, tax free bonds could be your best choice.
If the income on Tbills is taxed as interest, not dividends, then it does not qualify for the 15% rate (unless one is in the 15% bracket). Is this correct?Well, the good news is the qualified stock dividend 15% rate has a drop dead date, so maybe there won't be confusion after 2010.The only dividends that get the special rate are oridnary stock dividends. REITS dividends don't qualify, and nothing in the bond/fixed-income department, including funds.In case you hadn't noticed, the tax system is biased against people who can't afford to take too many chances with the stock market.
Thank you to everyone for their clear and concise replies! I made the dumb mistake of thinking that because my brokerage statements say "dividends," the interest from MM funds and Tbills is taxed at the 15% rate. Thanks very, very much for setting me right on this!
I went back in to the first part of the FAQs and changed the basic comment on taxes to be more explicit on this:• The income (interest, dividends) from most bonds, bond funds, and other principal preserving investments is fully taxed at your federal marginal rate (tax bracket), not at the lower rate for long term capital gains and “qualified dividends” in taxable accounts.---Even though they are called “dividends,” they do not qualify as “qualified dividends”—most stock dividends, except for from REITs, are “qualified dividends.”---So, when there are no reasons why you need to have access to money earmarked for principal preserving investments, it makes sense to hold these assets in tax-advantaged accounts (and stock assets in taxable accounts).And, from the Department of Redundancy Department (an old Firesign Theatre line), I added this early in the bond fund part.• Bond funds pay dividends, per share, based on the dividends paid by the bonds held by the funds, minus expenses (divided by the number of shares). ---The dividends include the premium or discount for bonds not purchased at par by the fund.• For most bond funds, dividends are paid at the end of each month and can be reinvested in the fund or paid into another fund (typically a money market at the same brokerage) or into an account elsewhere.• Bond fund dividends are taxed as ordinary income at your marginal federal tax rate (tax bracket) in a taxable account—these are not “qualified” stock dividends eligible for the 15% rate. ---Bond fund dividends from Treasuries are exempt from state and local taxes in taxable accounts. (The fund should provide a breakdown of what % of dividends is from Treasuries at the end of the year.) ---Dividends from Municipal (“tax-exempt”) bond funds are exempt from federal taxes. ---Municipal bond fund dividends that derive from bonds issued in your state are also exempt from state and local taxes. (If you use a general “muni” fund, with bonds from many states, the fund should provide a breakdown of what % of dividends come from each state.)
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