Newspaper article THE JOURNAL RECORD

Mixed Tax Breaks May Prove Harmful to Financial Health

Newspaper article THE JOURNAL RECORD

Mixed Tax Breaks May Prove Harmful to Financial Health

Article excerpt

NEW YORK -- The tax advantages that come with many types of investments can be strong medicine to help keep you in good financial health.

But as with pharmaceutical products, if you mix these tax breaks together without proceeding very cautiously, they can have some unwanted side effects.

For one obvious illustration of this problem, consider two common investment vehicles -- tax-free municipal bonds and tax-deferred retirement savings programs such as individual retirement accounts, Keogh plans and 401(k) plans.

Many investors have one or the other of these, if not both, as part of their money-management plans. But nobody would ever want to put them together by buying tax-free munis for an IRA, Keogh or 401(k).

The reason is simple. With the exemption muni bonds enjoy from income taxation on the interest they pay, these securities typically offer lower yields than taxable corporate bonds with comparable credit ratings.

If you were to hold a muni bond in an IRA, you would be accepting that lower yield without getting the muni-bond tax advantage, since taxes on investment income in an IRA are already deferred until you withdraw money from your account, perhaps many years from now.

What's more, when you do make withdrawals from the account, you will owe taxes on them even if some of the money represents earnings from a tax-advantaged investment. So you would wind up paying taxes on tax-exempt muni-bond interest.

Similarly, if you are offered some tax-deferred annuity product to put in an IRA or Keogh, you need to scrutinize it carefully.

Chances are the annuity's attractiveness depends heavily on its tax-deferred buildup of earnings, which is redundant in a retirement program that already offers tax-deferral.

The same goes for Series EE U.S. savings bonds, which also come with a tax-deferral feature. In all the promoting that is done of savings bonds, nobody ever recommends them for IRAs, Keoghs or 401(k)s. …

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