I have investment responsibility for an 89 year old aunt. Until recently, I have been reticent to make changes in the investment strategy she adopted years ago.Her living situation has changed recently. As a nursing home resident it is clear that starting with 2005 it is unlikely that she will ever owe much, if any, federal income tax. As an Illinois resident, she pays 3% income tax on a taxable income that includes almost every source of income.Years ago she invested about half of her assets in AMEX's AXP High Yield Tax-Exempt B (IHYBX). See:http://quotes.fool.com/custom/fool/html-news.asp?Symbols=IHYBX&tn-quote-btn=Go&page=%2fnews%2fsymbolnews.asphttp://finance.yahoo.com/q?s=ihybx&d=tSorry, I included the Yahoo reference because it brings up a whole lot more data, especially "total returns" whose definition is unclear to me.It is clear that this type of fund is best suited to someone in the top federal income tax bracket.It is clear that reinvestment of the same money in 90 day instruments via Treasury Direct would remove the 'fund load costs' and would yield an income stream that is no longer taxable by the state of Illinois.It is important to me to do what I can to maintain the income stream from her investments.How do I go about comparing the annual yield of the IHYBX vs treasuries on an after tax basis? I trust that treasuries are at least as secure a capital investment as the "medium and lower quality bonds and other debt obligations" described in the Fund Summary on the Yahoo site.Thanks,Baumgrenze
>> How do I go about comparing the annual yield of the IHYBX vs treasuries on an after tax basis? <<As a quick estimate, take the yield on a tax-free investment and divide it by ( 1 - state and federal income tax bracket).For example: A 3.3% tax-free yield with a combined 32% state and federal income tax bracket would be the taxable equivalent of 3.3% / (1 - .32) = 4.85%. A person in that combined bracket would need a 4.85% taxable yield to equal the after-tax performance of a 3.3% tax-free yield.Though it doesn't seem to be an issue in her case based on what you said, some who do this need to watch out for the AMT.#29
Thanks Ziggy,First, one very interesting point, the State of Illinois does not tenerally exempt income from municipal bonds from Illinois civil sources from their income tax. That is why there are no IL bond funds.That, in turn, explains my interest in Treasury Direct. Income from treasuries is, by law, exempt from state tax. Even Illinois can't tax it.The tough thing is teasing out of the data supplied by the Yahoo Finance website the rate of return for an existing investment. Perhaps my best shot is to do the following.I measure a snapshot of the mean value for the total investment for the past year (or perhaps for 2004 since I have the income information for 2004 from tax papers) i.e., I add together the value on 1/1/04 and 12/31/04 and divide by 2. I divide the return (reported as taxable and non-taxable (federal) by that number. That tells me what the investment made in raw % return for 2004, no? If I subtract 3% to pay the state of Illinois, that should give the after tax rate of return. I make these two numbers for 2004 to be 3.9% raw and 3.8% after tax.Today, I need to look at the capital value of the investment and what I can expect from 90 day treasuries (I consider this to be an acceptable maturity date for estate settlement purposes, should that need arise) and see what it tells me. At:http://www.federalreserve.gov/releases/h15/current/I think I understand that the current rate of return for 90 day treasuries is approximately 3.4%Am I correct? When I look at the information on rate of return supplied by Yahoo Finance it is not clear to me whether or not the number takes into account first year commissions and/or fees that may be different from an investment held for a longer time. The Total Annual Return table says that IHYBX paid 2.57% in 2004, which does not match my number.Thanks,Baumgrenze
I would instead consider a better muni fund of the same category. Try NHMAX or ORNAX. Both have significantly better performance and much less volatility.Sales charges are much like tax when you figure a return. If you can get a consistent net higher rate of return from a muni, then go the muni route. There is no sales charge on any reinvested dividends and capital gains on a mutual fund.
Please let me try to refocus this discussion.As a nursing home resident my aunt has significant 'medical' expenses. This means she will pay little or no federal income tax for the rest of her life.The Illinois Department of Revenue taxes almost all income (Social Security is exempt) at a 3% flat rate. There are no itemized deductions. For someone over 65 the first $3000 of income is tax exempt. The rest it taxed.In "Investing 101" I learned that municpal bonds and related mutual funds are priced on the assumption that the buyer will benefit from a tax exemption. The underlying theory is that it lowers the cost of municipal borrowing, "so everyone benefits."I cannot understand how it would benefit my aunt to invest in municpal bonds or funds based on them if this 'theory' has a basis in reality.If her "nest egg" that is now in a muni bond fund were to be invested in an obligation of the federal government, Illinois could no longer tax it. Therefore, in any return comparison, I need to consider the small but real 3% Illinois tax savings of such an investment.Is there something else I am missing?Thanks,Baumgrenze
Nope, you're absolutely right. Muni bonds only makes sense to investors who are in a high federal tax bracket and/or have highish state and/or local taxes. Ross Perot has a ton of them. She's giving away money that could be hers by being in muni bonds - or, well, refusing money that could be hers.Similar rational goes for federal bonds too, albeit not as much. They are tax deferred and exempt from local taxes, so the returns may be lower.If you want somethings stable, move her to a short term, high quality corporate bond fund. Or even a Money Market fund. Maybe some federal short term bonds for diversification if the returns aren't particularly different. If you want some or all with higher returns you can go for some longer term bonds too, but principal is more volatile in those (both up and down). But with little or no federal income tax to pay, tax-exempt funds are pointless, and give you less.
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