You Asked: Is it Better to Invest in a Tax-Free or a Taxable Mutual Fund?  header image

You Asked: Is it Better to Invest in a Tax-Free or a Taxable Mutual Fund?

So, now that you’ve thought more about your financial goals – whether that’s saving for your child’s college education, retirement or you’re working toward a big purchase – consider what options are available to help you achieve these goals.

Tax-free vs. Taxable

Typically, a tax-free mutual fund is made up of municipal bonds and other government securities. Such securities are attractive to many investors because returns are tax free, often at both the state and federal levels. However, they also tend to provide lower pretax returns than comparable securities issued by nongovernmental entities. It is imperative that you consider total after-tax returns when you are comparing a tax-free fund with a taxable fund. Whether or not a taxable fund is a better choice for you will depend in large part on how much of your returns are likely to go directly to federal, state, and local taxes at the end of the year and whether you are subject to the alternative minimum tax.

Taxable:

To determine your approximate after-tax rate of return on a taxable investment, multiply your rate of return by 100 percent minus your tax rate:

Pretax return x (100% - tax rate) = After-tax rate of return

For example, say you are in the 25 percent tax bracket and earn a pretax return of 10 percent on an investment. Your after-tax rate of return would be 7.5 percent, calculated as follows:

10% x (1 -.25) =.075 or 7.5% after-tax rate of return

In addition, consider whether the fund will be held in a qualified pension or retirement plan. If your returns will automatically accumulate tax deferred in an IRA or 401(k), there may be no reason to accept lower returns in exchange for a tax-free feature.

Tax-free:

If you are risk averse, you may decide on a tax-free fund. The securities that it holds will be backed by the full faith and credit of the issuing bodies, typically state governments or municipalities. This feature coupled with the tax advantage gives some investors an added comfort level.

Note: Before investing in a mutual fund, carefully consider its investment objectives, risks, fees, and expenses, which can be found in the prospectus available from the fund. Read it carefully before investing. Tax-free bond funds are subject to the same inflation, interest-rate, and credit risks associated with their underlying bonds. As interest rates rise, bond prices typically fall, which can adversely affect a bond fund's performance.

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Achieving your financial goals takes time and planning. Connect with a Farm Bureau agent to learn more about options that can help you reach those goals.

Source:

RBC Wealth Management, a division of RBC Capital Markets, LLC, Member NYSE/FINRA/SIPC. © 2017 All rights reserved.

Securities & services offered through FBL Marketing Services, LLC+, 5400 University Avenue, West Des Moines, IA 50266, 877-860-2904, Member SIPC.

Agent must be a registered representative of FBL Marketing Services, LLC to discuss mutual funds. Neither the Company nor its agents give tax, accounting or legal advice. Consult your professional adviser in these areas.

Investors should consider the investment objectives, risks, and charges and expenses of a fund carefully before investing. Prospectuses containing this and other information about the fund are available by contacting your Registered Representative. Please read the prospectuses carefully before investing to make sure the fund is appropriate for your goals and risk tolerance.

RBC Correspondent Services+, a division of RBC Capital Markets, LLC, Member NYSE/FINRA/SIPC, provides clearing and execution services for FBL Marketing Services, LLC. The referenced product and/or service is made available through that relationship.

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