My Favorite Way to Beat Obama's Tax Hikes


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Many successful investorswill be in for a shock during upcoming tax seasons. There is nothing worse than having a banner year in thefinancial markets , then having to give a large portion of it to Uncle Sam in the form oftaxes .

Frankly, I'm concerned that the pain is going to be worse for winning investors who have failed to prepare themselves for the new era of higher tax rates.

Here's what the new tax lawsmean to you
If you are in the toptax bracket , meaning you earn more than $400,000 (or $450,000 for married couples), then yourmarginal tax rate will jump to 39.6% and the rate on long-term capital gains anddividend interest will increase five percentage points to 20% for the 2013tax year . A new 3.8% tax related to theAffordable Care Act (more commonly known as "Obamacare ") and a 0.9%Medicare surtax are also going to hittaxpayers who make more than $200,000 (or $250,000 for married couples) in modified, adjusted gross income. 

That's why it's important to design yourinvestment portfolio in the most tax-efficient way, even if you are under this threshold.Investing within a retirement account and diversifying into tax-advantaged instruments is the primary way to lessen your tax burden.

And one of the most widely used tax-exempt instruments in themarket are municipal bond funds. 

Although tax-exempt municipal bondsyield less than taxablebond funds , they often make more investing sense because of their tax ramifications.

Let me explain...

Municipal bonds, also known as munis, are debt instruments issued by public entities like cities, states and counties, which use the proceeds tofund various public works projects such as roads, schools and power plants. Thesebonds can be based onrevenue or general obligations.issuer , which can allocate or increase taxes to assure the interest is paid andprincipal is returned. 

Why do munis make sense now?
The short answer is because the interest earned from owning municipal bonds and municipal bond funds is generally exempt fromfederal income taxes . In addition, depending on the issuer, they can be exempt from state or local taxes. 

With all this information in mind, here are two of my favoritemunicipal bond investments ...

1. Invesco Value Municipal Income Trust ( IIM )
This fund is built with tax-free,fixed-income instruments consisting primarily of municipal bonds rated "A" or better. It yields about 5.6%. If you are in the 35% tax bracket, then this tax-free yield is equivalent to an almost 8.6% taxable yield. 

This example clearly shows the benefits of investing in tax-free municipal bond funds. As taxes increase, so will the benefits. IIM is also insured. This means the interest and principal are guaranteed to be paid. And I'm not the only who feels secure. My colleague Amy Calistri recently added this fund to her Daily Paycheck portfolio.

2. Black Rock Municipal Bond Investment Trust ( BIE )
Launched in 2002, thismunicipal bond fund invests in fixed-income markets in the United States. It's well diversified across the space with investments in hospitals, water, sewer, education, tax, housing, lease, power, tobacco, transportation and industrial pollution control sectors. It yields roughly 5.5%, which is equivalent to an 8.5% taxable yield for investors in the 35% tax bracket.

Risks to Consider: It's critical tonote that the capital gains from distributions or from the sale of a bond are still subject to taxes. The new 3.8% Obamacare tax, for example, does not include income earned from municipal bond interest. Therefore, if you are dependent on fixed income, then this fact alone could influence your decision to allocate additional funds into municipal bonds as part of your tax-advantaged portfolio.

Action to Take --> The personal investment value of municipal bond funds is directly related to your tax bracket. If you are in the 15% bracket, then it makes little sense to accept the lower yields of municipal bonds. However, from tax brackets of 25% and up, municipal bonds increasingly make sense. Always be certain to consult a professionaltax advisor prior to making any investment decisions.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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This article appears in: Investing , Investing Ideas , Stocks
Referenced Stocks: BIE , IIM

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