Which investment option makes more sense for you in 2008: a taxable certificate of deposit from a bank or a tax-free municipal bond?
Truth be told, the real investing question isn't limited to just these two options. What matters is whether it makes more sense for you put your money into an investment for which you'll need to pay taxes on any gains you might make versus one whose investment gains will not be taxed at all. Typically, the taxable investment vehicle will offer a higher rate of return, so the question comes down to finding out if that higher return is enough to overcome the taxes you would have to pay.
The answer to that last question depends on what you expect your marginal tax rate will be in 2008. And that's where we come in, because we've developed the tool you need to do the math to find out! Our tool will provide a good first approximation of your marginal tax rate. It's important to note that this calculation is only a first approximation since you may or may not be eligible for a variety of tax credits that might bring you down into a lower marginal tax bracket, which this tool doesn't take into account.
To use the tool, you might find it useful to refer to your tax return for 2007, especially if you expect to have a similar amount of income and have to pay a similar amount of taxes in 2008. If you expect your numbers will be significantly different this year, then go with the appropriate numbers for what you expect. The tool will find your average tax rate (your taxes as if you paid a simple flat tax on your taxable income), your marginal tax rate (the tax rate you pay on the last dollar of income you earn), and finally whether a taxable or tax-exempt investment makes more sense for you.
One last thing: there's a neat trick you can use to find the percentage spread between the taxable and tax-exempt investment options you might be considering without having to do the math yourself. You can simply write out the math to subtract the rate of return for the tax-free investment option from the rate of return for the taxable investment option, then divide the result by tax-free rate of return and multiply by 100.
Here's an example. Let's say you're choosing between a taxable investment that would give you a 5.7% rate of return and a tax-free investment that would pay you a 4.4% rate of return. Enter the following into the entry field for the tool for the percentage spread, parentheses, slashes, asterisks and all!:
(5.7-4.4)/4.4*100
An even neater trick is to copy and paste this example, swapping the numbers with those that apply to your investment choices! Remember, 5.7 is for the TAXABLE investment. 4.4 (in two places) is for the TAX-EXEMPT investment!
One neat change in this year's edition of our tool is that it now does the math for all the years for which we've featured it! This is cool because now you can see how adjustments for inflation may have moved you down into a lower marginal tax bracket. Try it with our default data beginning in 2004!
Finally, for more information about the math involved behind this tool, see Bruce Bartlett's column "Before You File... do a little extra math" from National Review back on March 30, 2005. In previous editions of this tool, we had linked the article at another source that no longer appears to be current....
Previously on Political Calculations
- Investing and Income Taxes in 2007
- Investing and Income Taxes in 2006
- Marginal Tax Rates and Investment Choices
Labels: investing, taxes, tool
Welcome to the blogosphere's toolchest! Here, unlike other blogs dedicated to analyzing current events, we create easy-to-use, simple tools to do the math related to them so you can get in on the action too! If you would like to learn more about these tools, or if you would like to contribute ideas to develop for this blog, please e-mail us at:
ironman at politicalcalculations
Thanks in advance!
Closing values for previous trading day.
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