Over the past number of months, the feds have raised interest rates to levels we haven’t seen in many years. Now, it’s possible to earn real money when depositing funds in a high yield savings account or CD.Â
In this post I wanted to quickly recap a few options of where to park cash for tax savings optimization in place of the traditional savings account. Please add your own thoughts and suggestions in the comments below.
- U.S. Treasury bills are exempt from state and local taxes. (We wrote about using Treasuries in place of a savings account in this post.) Depending on location, you might save 10% or more by purchasing treasuries instead of traditional savings account. For example, earning 4.50% from treasuries can potentially be more worthwhile than earning 4.70% in a traditional savings account.
- There are many federal money market funds you can buy within a brokerage account which are comprised partially or fully of U.S. Treasuries. Whatever component of the fund is from U.S. Treasuries is exempt from state and local taxes.
- Note, these tax savings don’t get computed automatically. Be sure your accountant calculates the savings. If you’re using a tax software, be sure to input the savings.
- We wrote more about these funds and some examples in this post.
- I Bonds are also U.S. Treasuries and are exempt from state and local taxes. These have volume limitations and don’t run fully in concert with regular interest rates, but I thought it worth mentioning. I Bonds also have the advantage of being taxed in the year you break the bond, so you can tax plan and choose the right year you want to cash out and realize the income. We wrote about buying I Bonds a number of times in the past.
- Municipal bonds are exempt from federal taxes. Municipal bond funds make it easy to buy these.
- We wrote about these briefly in this post.
- For most people, the exemption from federal taxes far exceeds the benefit from state and local tax exemption.
- Moverover, many states exempt their own state’s municipal bonds from state taxes. Thus, one can potentially have earnings which are fully tax-exempt.
- Important note, municipal bond funds often earn less than federal money market funds and the tax savings it might not be worth it, depending on your tax bracket and rates.
- Also note, these funds are usually not as steady as federal money market funds which invest heavily in things like U.S. treasury bills. There is often fluctuations in the value of the actual fund making it different from a simple ‘interest rate’ play and something closer to an investment. Still some might consider it for the tax savings or as part of a broader investment strategy.
- Finally, as noted above, these tax savings don’t get computed automatically. Be sure your accountant calculates the savings. If you’re using a tax software, be sure to input the savings.
A while back we recommended CFG Bank money market account as the best simple high yield savings account (and there are a few similar accounts that are just as good). Personally, I’ve been using Vanguard’s default federal money market fund (VMFXX) for my cash since it’s been tracking close to the top rates from savings accounts. I’m now switching over my funds to VUSXX for the additional state tax savings since that fund invest the large majority in U.S. Treasuries which are exempt from state taxes. (See this pdf for exact percentages in 2022.)Â Fidelity also has similar funds (SPAXX, FDLXX) – those funds are earning a bit less, probably due to higher expense ratios.
VUSXX’s % of fund in Repurchase Agreements has further crept up to 24.30%. Does anyone know if shortly after the end of 2023, Vanguard will provide an accurate % that could be used for state tax exempt calculations / tax filing purposes? It was 0% until around 1/31, then 23.2% until recently (I think I just saw this sometime last week), and now I just noticed 24.30%. This is not something that I’m going to be able to continuously follow throughout the year, and I am looking for simplicity more and more, not complexity. But, if I know I’m going to get an answer about this, I’ll bite for at least the $3k minimum as I already have a Roth IRA at Vanguard and am looking for somewhere to stash the $6.5k Roth IRA max contribution for 2023CY ASAP before I go off the grid for a while.
Many money market account investment assets are short term holdings, so the manager decides what is purchased as holdings mature. The percentage for the year that is important for the tax return is NOT the portfolio holding percentages. It is the income percentages that are used in calculating US Government obligations and non-Government obligations is what is reported on the state tax return. The manager can have 50% in Government obligation holdings for three months and then have 80% for the remaining nine months. The percentages are a moving target. Many money market fund profiles include the portfolio holdings every month over the year by percentages. However, the income percentages are not usually reported. I noticed that many money market Government funds are adding repurchase agreements to their portfolio when it was not included in previous years. The funds have a requirement that at least 99.5% of their holdings must be in Government related securities to qualify as a Government money fund. They may be having some issues in finding enough direct Government securities to purchase and have had to resort to repurchase agreements backed by Treasury securities to be able to continue to qualify as a Government money fund. Many have adjusted their investment strategy information on the prospectus to reflect these changes.
Roth IRA accounts should not be concerned with the percentage income from the portfolio since the earnings are not taxed on the Federal return.
All three Vanguard money market funds (VUSXX, VMFXX, VMRXX) hold repurchase agreements in their portfolios now. If you don’t like what they did, move your money to another fund family that offers 100% Treasury only holdings.
“Roth IRA accounts should not be concerned with the percentage income from the portfolio since the earnings are not taxed on the Federal return.”
2023 could very likely be the last year I have earned income (retired earlier this year), thus my preference for choosing to have one of these funds in my Roth IRA vs. buying them as a separate investment at a traditional brokerage.
You are welcome Jared. To answer your question about Vanguard providing the percentage information at the end of 2023, yes, all mutual funds report the direct Government obligation income versus the non-direct Government obligation income percentages, so that you can compute the amount of income to be subtracted from the 1099-DIV amounts that you will see by the end of January 2024. They or you do not need to report a monthly income percentage figure since the overall total for the year is the only thing that is important. You can monitor the monthly portfolio information and see the trend as to whether repurchase agreements investment go up or down as the year progresses. But, if you wish to avoid investing in repurchase agreements, you would need to invest in 100% Treasury funds like SNSXX, GABXX, SMUXX, CJTXX, IUSXX. The Fidelity Treasury Only Money Market Fund (FDLXX) is currently 95% treasuries and 5% something else.
Repurchase agreements (repos) have been brought up in lawsuits about state taxation of these items. They are short term loans that last a few days to a few weeks. They are usually backed by Treasury securities acting as collateral. The argument that since US Treasuries are backing the “repos”, the income should be state tax exempt. However, the ruling stated that the repos are not direct US obligations and are being used as collateral making the whole financing deal not representing an actual direct US obligation of repos. So, several state court rulings have disallowed treating repos as state tax exempt.
Since you are near the end of your work career, I understand your desire to put your last IRA investments into more stable forms of investments. I myself am close to retirement and also will have to stop my IRA, 401(k), and HSA contributions when I retire. I decided to go a bit risky with my remaining IRA contributions and put them into a semiconductor and health care mutual funds. Those sectors produced high returns before the pandemic and did much better than bank accounts even with the recent market downturn. I don’t expect to have a large sum invested in them since I will retire soon. Most of my retirement funds are in index funds and income funds.
Jared, I am still working and over 65, so the first Medicare enrollment opportunity arrived last year that will avoid the late enrollment penalty. Since I decided to continue to work and still have eligible medical insurance through my employer, I can postpone the Medicare enrollment until 8 months after I actually stop working. The Medicare rules say that HSA contributions must terminate when you enroll in Medicare. Medicare Part A coverage goes back six months retroactive before you start coverage. So the HSA contributions must stop six months before Medicare coverage has been applied for, otherwise you could be liable for an HSA ineligible contribution penalty. I am still contributing to the HSA now and will end it by the end of next year (2024) when I retire. Since I have the 8 month period after retirement to apply for Medicare, I can apply for Part A and B in mid-2025 and with the retroactive coverage of Medicare that goes back six months (that would be at the start of 2025), my HSA contributions must end by that same time. This is what was mentioned in the retirement information that I saw on the retirement website information.
Jared, It looks like you have a while before considering enrollment in Medicare. I am not required to enroll in Medicare even after i actually retire since I have the option to just remain in the employer medical plan in retirement. There is a tradeoff to consider between enrolling in Medicare or remaining in the employer HDHP with the HSA option. Many of the insurance company plans for retirees provide a stipend to help cover some of the Part B cost if you choose Medicare with the retiree plan. Since the Government assumes some of the medical costs, the insurance company will offer a better benefit for those that opt into Medicare. The issue with staying with the HDHP plan with the HSA into your older years runs the risk of being saddled with more of the bills for you to cover especially with the high deductibles associated with the HDHP coverage. The HSA money will help to cover some of the deductible, but if you have a chronic medical condition or require expensive medical care, the HDHP plans are not for people with big medical bills. If you later then decide that it is better to get Medicare coverage, you will be hit with a permanent late enrollment penalty to your monthly premium amount.
In paragraph 2, Chuck notes that the portion of a money market fund comprised of US Treasuries is exempt from state and local taxes. As far as I know this is not specific to money market funds, but also applies to ETFs and mutual funds.
Does anyone know of resource (broad, if not universal) for locating the percentage of income derived from US Treasuries for a particular security? Over the past few years I’ve combed through files on fund company sites, often relying on the assumption that the number was probably zero if I could not find it. I’m wondering if there is a (publicly available) better way.
I put a pdf link in the post from Vanguard’s 2022 numbers
During tax time, I would usually go to the fund’s website and see the breakout of holdings. So if 80% of the fund is held in Treasuries I would estimate that 80% of the earnings I received from that fund is exempt from state and local taxes. For ETFs, your 1099 sometimes has an indication that income from the fund may have come from Treasuries, depends on the clearing firm for your broker.
VUSXX is available for free purchase at JPM Self Directed, E*Trade and of course Vanguard. Don’t forget to get a bonus if you open with the former two.
Solid tip!
It’s now free at Ally too, I believe.
I think it would be good for
William Charles to do a post some day on brokerages where you can buy VUSXX for free, as it’s state tax exempt, offers almost the highest liquid rate out there, and I anticipate more and more brokerages will be adding it on their “free” list.
Not the best with numbers. What’s the yield? Is this better than T bills?
No, but simpler: https://investor.vanguard.com/investment-products/mutual-funds/profile/vusxx
So as of today it’s 4.46%? Is that fixed or does it fluctuate
“Although the fund invests primarily in short-term U.S. Treasury bills, the amount of income that a shareholder may receive will be largely dependent on the current interest rate”
Buy t-bills if you want to lock in an interest rate
I am not an expert… I didn’t take a look at the individual holdings of those funds to see if they’re identical, but keep in mind some funds are 100% treasuries while others are a mix of treasuries and corporate bonds, etc. Have to make sure it’s apples to apples.
After that, look at the 7 day yields. VUSXX tends to have the highest 7 day yields these days. For example, currently 4.5%. Likely due to the low expense ratio:
https://investor.vanguard.com/investment-products/mutual-funds/profile/vusxx
I would look at the 7 day yields of the other two you mention.
I would also look at minimums to invest. For example, VUSXX tends to be $3000 minimum. Other funds might be $100k.
Finally, take a look at whether the fund is state tax deductible. VUSXX generally is which gives it a good boost.
Also looks like it’s available on TD Ameritrade with a $3000 minimum initial deposit
At no transaction fees? I’d be surprised.
Fidelity has an institutional class version of FDLXX with lower fees, FRSXX, with a current net expense ratio of 0.14%: https://fundresearch.fidelity.com/mutual-funds/summary/31607A802
It normally has an initial investment minimum of $10,000,000. However, if you have a Wells Fargo Wellstrade account, you can purchase FRSXX with no minimum and no fees. An option for those who don’t have a Vanguard account, but want a treasury only money market with low fees and happen to have a Wellstrade account
I am not a tax expert, always wondered what the rules were in terms of deductions one can take to offset the interest earned from HISA. For example, IRS doesn’t tax on the Credit card SUB as we are spending to earn the SUB. But, they do tax on referral bonus earned if no spend involved. Similarly, can we deduct the spend we are forced to make via debit card to earn a higher interest in the High interest checking and savings account?. These 2 spends (CC SUB and HISA Debit card) are no different as they force you to spend to earn something.
If such a thing is possible, It may help for those who fall outside of the standard deduction bracket.
I am not aware of any supportable position to do what you are proposing.
I also don’t think your examples are equivalent as SUB & cc rewards are essentially discounts (not taxable) but jumping through hoops to increase interest income is not and the full income is taxable.
Anyone invested recently in Annuities share their experience?. I see 7 year rates offers 5.8pct. Even with 10pct addl tax after 7 years (if before 59.5 yrs age) in a 20pct tax bracket it comes to 4.8pct return
Note: I believe you also pay income tax even on the part that got 10% taxed, so so it could be more like a 12-13% tax to deduct, depending on your tax bracket. Hopefully this makes sense.
Correct. The 10% early-withdrawal levy is a penalty on top of regular income tax.
Right, that is what i said earlier. In my example, 100K invested over 7 years gives $48388 in interest. So i am deducting 20pct (tax bracket-$9677) and additional 4838 (10 pct early withdrawal IRS tax) – so net is $48388-9677-4838 = 33873 in return which is 4.83 pct return over 7 years after taxes. correct?.
Ah, okay, sounds good
If you purchase the multi-year guaranteed annuity, and at maturity, let it renew into a new multi-year guaranteed annuity, you may be able to avoid the “before 59.5 yrs old 10% penalty”. Not positive, but I think that is how it works. BTW, I use these products, along with CD’s, to generate ongoing income. In my situation, I take the monthly interest from the MYGA’s rather than let it compound till maturity. Paying the income taxes on the annuity interest annually is better for me than the big interest payment at maturity that would push me into a higher tax bracket. Also, before purchasing your annuity, check with your State Insurance Guaranty Association to see how much insurance coverage they provide.
Its not standard to calculate your returns or interest rates by averaging the interest earned over 7 years instead of annualizing the interest. Doing it that way overstates the actual returns/interest. Using an annualized rate, your net after-tax annual interest would be about 4.254% in the scenario you provided.
NBG, I you don’t mind sharing, where are you seeing the 7 year MYGA at 5.8pts?
Chuck won’t touch the crypto stuff but then shills government bonds as they’re on the brink of defaulting? Pot meet Kettle
/s
There is no comparison. Bonds are backed by the government while crypto is backed by, well nothing really. If the U.S. government defaults to where it can’t pay the treasury bonds, there will be a lot more important things to worry about.
The US gov shouldn’t default since its debts are denominated in US dollars and it can print as many $$$ as it wants. The so called dept ceiling is imaginary, really.
Strictly speaking, the US government has defaulted 4 times in its history. 1790, 1861, 1933, and 1979.
I have money in crypto. If you think US Treasury bonds are anywhere near the risk of crypto projects, you need a serious reality check. There are plenty resources to help you understand the asset risk spectrum.
The math for this is tricky. Your breakeven yield between federal treasuries and prime money market accounts is a function of both your state and federal marginal tax rates. For example, if your state rate is 10% and the treasury is yielding 4.5%, your break-even rate is *higher* than 5% because the extra yield you need to pay state income tax also is federally taxed.
The breakeven ratio ends up being (1-federal)/(1-federal-state). This makes federal treasuries excellent right now for all my high-income homies with blue state Stockholm syndrome.
Worth adding that taxes on I Bond interest are deferred until you withdraw them. That makes it like a traditional nondeductible IRA and is a significant advantage in tax treatment compared with treasuries and CDs held outside of tax-advantaged accounts. (You can also choose to pay taxes on I Bonds annually, but there’s extra record-keeping hassle that way, and most people are better off deferring taxes.)
I’ll add a note
To add one point – VUSXX is considered nominally more secure than VMFXX. Rates are not identical, but pretty close.