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Money Smarts
Chapter 12 Money Smarts: Which Type of Bond?
A tax-exempt bond might give you a lower
tax bill, but is it the best investment? As always, the answer
depends on the individual investor’s goals and circumstances.
Most bonds pay interest to bondholders
semiannually (twice a year). If the investment is in a corporate
bond, the interest earned on the bond is subject to federal
and state income taxes. If the investment is in a municipal
bond, the interest is not subject to federal taxes. In some
cases the interest is also not subject to state taxes.
Go to the BusinessWeek Online
Personal
Finance Investing calculators. Scroll down to the Bond
Calculators and click on “Should I buy a tax-exempt
or taxable bond?”
Input the following values:
| |
Tax-
exempt |
Taxable |
| Price you paid (% of face
value) |
100% |
100% |
| Face value |
$5,000 |
$5,000 |
| Coupon rate |
4.00% |
6.00% (This is the bond’s interest
rate.) |
| Months until maturity |
60 |
60 |
| Months until you sell bonds |
|
12 |
| Market rate when you sell |
|
5.00% |
| Your federal tax rate |
|
15.00% |
| Your state tax rate |
|
3.00% |
| Your coupon income is: |
|
Spent |
Click on the “get your results”
button and answer the following questions.
- If you hold the tax-exempt bond until maturity, what is
your rate of return before taxes?
- What is your rate of return on this bond after taxes?
- If you hold the taxable bond until maturity, what is
your rate of return on this bond after taxes?
- Which bond is the better after-tax investment if you
hold it until maturity? Why?
- What is the difference between tax-exempt income
and tax-deferred income?
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