Avoiding Tax-Exempt Money Market Funds in Your IRA

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Should I buy a tax-exempt money market fund in my IRA?

Avoiding Tax-Exempt Money Market Funds in Your IRA

A tax-free or tax-exempt investment vehicle often perks up the ears of investors, but believe it or not, it's easy to make bad decisions when investing in tax-exempt vehicles, one of which involves purchasing them in your IRA.

Tax-exempt money market funds are generally comprised of government securities from local municipalities. The growth of these funds is generally exempt from federal taxation and may be exempt from state taxation as well. Because they have the added benefit of tax-exempt growth, they offer a low interest rate (or yield). But because IRAs already offer tax-deferred growth by their very nature, investors with tax-exempt money market funds in them just get a low return without any additional tax-saving benefits.

A better option for IRA investors is to spend some time and compare money market funds. Choose a fund with a high yield and buy it with the proceeds within your IRA. As long as the growth of the fund is within the IRA, you won't pay taxes on it. If you have a traditional IRA, you'll pay taxes as you begin to take distributions from your IRA, but you'll pay taxes based on your lower-income, senior tax bracket.

   

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