What are Tax-Exempt Money Market Funds

Tax-exempt money market funds invest only in short-term municipal securities. These are issued by local governments and government agencies to raise money for their operations.

These local governments include:

City governments

County governments

State governments

School systems

Public hospitals

Public stadiums

There're over 50,000 local government agencies that issue municipal bonds.

And many of them issue the short-term type of securities, municipal notes (or munis), that money market funds specialize in:

Tax Anticipation Notes (TAN)

Revenue Anticipation Notes (RAN)

Tax and Revenue Anticipation Notes (TRAN)

Bond Anticipation Notes (BAN)

Variable Rate Demand Bonds -- Lower Floaters

(These are long-term tax-exempt muni bonds converted by a dealer into a short-term security.)

To encourage investors to buy these local-government securities, the federal government exempts the income you receive from federal taxation.

Before you decide that not paying taxes is a "no brainer" and rush to put your money into a tax exempt market fund, you must understand that because of their (federal) tax-free status, these securities pay less interest than equivalent notes issued by businesses. Therefore, the dividend yield from these funds is less than the yield of general purpose funds.

To figure out whether it's better for you to park your money in a tax-exempt fund or a general purpose fund, first find out what your marginal tax rate is.

Then you must calculate the equivalent yield. Then you compare the equivalent yield of the tax-exempt fund to the actual yield of the taxable general purpose fund, and put your money in the one that pays the most.

The tax-exempt equivalence equation is:

Taxable equivalent yield = tax-free yield/(1 - tax rate)

For example, if you're in the lowest tax bracket of 10% and you're evaluating a tax-exempt fund that pays 2% --

Taxable equivalent yield = .02/(1 - .10)

Taxable equivalent yield = .02/.90

Taxable equivalent yield = 0.022222%

Therefore, if you can find a taxable fund that pays more than 2.22%, you're better off putting your money into that fund and just paying the taxes.

Of course, the higher your tax rate, the more money you would save by going with a tax-exempt fund

If the two yields are almost the same, it's a toss-up. Go with whichever money fund is most convenient to you. Remember that the yields of both funds will change in the future, due to changes in the prevailing interest rates in the country. Plus, it's likely that in the future your tax rate will change due to changes in your income level or changes in the tax laws.

If you live in certain high-tax states, it may be worthwhile for you to find a tax-exempt money market fund that invests only in municipal securities issued within your state. This means that you not only do not pay federal income tax, you won't pay state income taxes either. So if you're in California, New York or some other high-tax state, check that out. Those of you living in Florida, Nevada or any state with no or low taxes, be grateful.

What are the advantages of mutual money market fund accounts

Click to watch brief (30 second), exciting video on finding financial freedom through investing for income . . .

Now experience for yourself the joy of securing your retirement through income investing!

Want more income -- now or when you retire? Get your free eCourse:

Learn the Secrets of Investors Who Make Money in Both Bull and Bear Markets . . . Good Times and Bad!

Before the subprime mortgage mess makes stock market goes down more . . . before the stock market goes up, making dividend paying stocks more expensive . . . before the rising cost of gas, gold and food -- and the sinking U.S. dollar -- put the world into a recession . . . before retiring baby boomers start selling off their growth stocks . . . before you need investment income just to eat!

  

7 Reasons to Invest for Income -- NOW More Than Ever

Rick Stooker

• The greatest secret to income investing (Einstein called it "The most powerful force in the universe")

• What -- historically -- gives stock market investors 1/2 of their total returns (from 1929-1954; 1966-1981; and 1999-mid-2008 it was the ONLY way to make money from the stock market!)

• How to avoid suffering from accounting fraud. Automatically keeps you from throwing you money away on future Enrons, Tycos, and WorldComs

It's easy. Just enter your first name and email address into the form below.

(NOTE: I greatly respect your privacy. I will never sell, rent, share or give away your email address to anyone. There is no obligation. You can unsubscribe at any time. After you click the button, you'll be taken to a page to thank you.)

Or, you can subscribe to the 7 Reasons to Invest for Income Now More Than Ever RSS feed. Just click on the orange RSS feed icon below:

Disclaimer:

I am not a financial advisor. I am not a broker. I am not a financial planner.

I have no professional licenses.

I am a wide reader and an independent thinker and this site gives my opinions on the subject of income investing.

Nothing in this site is to be construed as professional advice.

I am not responsible for the results of your investment decisions.

Past results are no guarantee of future returns.

You must read, think over what I say, make your own investment decisions and take responsibility for your own life, including the results of your investment decisions.

Continuing to stay on this site implies your acceptance of these terms.

Income Investing Site Full Website Agreement

Fixed Income Investments

Growth Income Investments

Why Income Investing