Indiana offers some tax benefits to investors that are unique to our state. Municipal Bonds are very popular here. These bonds are a great (and Safe) way to earn more interest on your savings. The interest you earn on a bond from ANY STATE is FREE from Federal Tax, State Tax, and Local Taxes!
Municipal Bonds, or Munis have been used for over 200 years as a way to raise money to build or improve schools, hospitals, libraries, and roads. These days, stadiums have also been funded by having bonds issued. Once the bond is issued, you can loan money to the project and be repaid with interest which is free from Federal taxes. When the bond matures, you get the amount back which you loaned to the project.
If the bond is issued by your home state, your interest may also be free from State and Local taxes.
Again, the benefit for us “Hoosiers” living in Indiana is this. It doesn’t matter which state the bond came from. We enjoy interest income on any muni bond which is free from Federal, State, and Local Taxes!
That may be worth an additional 1.5% – 2% or more on your savings, depending on your tax bracket.
(Check with your advisor when buying bonds to see if you may be subject to Alternative Minimum Tax, depending on your total income.)
Currently, http://www.bankrate.com/ (as of Feb. 4, 2010), shows us what the highest rates are for a 1 Year CD
(1.7%) and a 5 Year CD (3.55%). Dave Ramsey refers to these as “Certificates of Depression”. You can see why!
Did you also know that CDs are RISKY? Why is that, you ask?
Easy – You LOSE Future Buying Power!
Let’s do the math, and see which option may be better for long term savings.
5 Year Municipal (Investment Quality) Bond at 5%
$10,000 x .05 = $500/year.
$500 x 5 years = $2500 (TAX FREE)
Most Bonds pay interest twice per year, directly to you the investor, so you will get 2 checks each year for
$250 for 5 years. When the bond is due, you get the $10,000 back. That may also happen if the bond is called early, but that’s another lesson.
5 Year CD at 3.55%
Remember that was the BEST rate in the US today on http://www.bankrate.com/.
$10,000 x .0355 = $355/year.
$355 x 5 years = $1775, and you WILL PAY TAXES on this.
Hmmmm……let’s see…..I can get $2500 in interest that is tax free OR $1775 in interest that is taxable. I wonder which one I should pick……
Did you ever wonder how banks make money? They use your money and either loan it or invest it.
Now you can see why your bank may not share the muni bond idea with you.
You may also contact me for more information on 401(k) plans or IRAs at http://www.helpmy401k.us/.
You may also contact me on Linked In at http://www.linkedin.com/in/dvoelker or Twitter at http://www.twitter.com/deanvoelker. I also host a weekly financial advice program, Improving Your Financial Health at http://www.blogtalkradio.com/401kcoach.