Investing 401

Developing a solid tax strategy is critical to making sure your profits don't turn into a loss

“However,” says Holland, “many investors are leery of owning bonds from another state or municipality. But they find that paying the additional state income tax is worth the reduction in risk you get by having a diversified portfolio of municipal bonds from a variety of states and related entities.”

For example, suppose you buy a $25,000 out-of-state municipal bond paying you 4% interest, or $1,000 per year. If your state and local tax rates add up to 5%, you’d owe an additional $50 per year in tax (5% of $1,000) netting you $950.

However, that $50 state tax payment probably would be tax deductible, saving you $15 in a 30% federal tax bracket. So you’d wind up with a net tax cost of $35 ($50 minus $15) and net interest income of $965 instead of $1,000. Is that extra $35 per year, on a $25,000 investment, worth the risk of loading your portfolio with bonds from one area? “Local economic distress may hurt the bonds’ ratings and send your bond prices lower,” says Holland.

As April 15 approaches, investors need to begin formulating a tax strategy that will help them keep more of their portfolio gains in 2002. What can you do with your losing investments to offset the tax consequences of high-performing investments in your portfolio this year? Should you consider investing in more tax-friendly investment vehicles? Consult a qualified tax professional if you need to, but be sure to use the tax laws to your advantage. It is critical that your retirement funds don’t end up enriching Uncle Sam.

The Ernst & Young Tax Saver’s Guide 2002Edited by Peter W. Berstein John Wiley & Sons$16.95)

J.K. Lasser’s Online Taxes Edited by Barbara Weltman John Wiley & Sons$16.95

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