AssetBuilder Inc. Registered Investment Advisor - Simple Investing. Smart Future.

My wife and I are good savers. We're able to put away about $3500 monthly. We allow this money to accumulate in an ordinary money market fund until the end of the year. From the accumulation we pay the property taxes, insurance premiums and fund the IRAs and our son's Coverdell account. We fully fund the IRAs each year and adjust our unmatched contributions to the 403(b)s just enough to reduce our AGI to make the IRAs possible. My wife is eligible for California's CalSTRS retirement as well has her 403(b) and Roth IRA and I will receive Social Security as well as the 403(b) and Roth IRA. We try to keep about $30,000 in cash in the money market fund, but I think it's too much, given our monthly salaries. We're contemplating one of two alternatives for the "extra" cash and would appreciate anyone's thinking on them.

First, among our account types (traditional IRAs, Roth IRAs, 403(b)s, taxable mutual funds, etc.) we don't have much in the way of federally insured deposits. Everything's in mutual funds except for our everyday checking and savings accounts at the credit union. We could establish a sort of monthly deposit "ladder" of CD's with one of those online banks, depositing $1,000 each month in a new CD, so we'll have a maturing, federally insured cash account available each month. We could roll these over or take them as "income".

For a second idea, we could regularly invest in a municipal bond fund, exempt from U.S. and California income taxes. I haven't yet penciled this out,  but our Federal Tax Rate for 2007 was 25%, so it might be worthwhile. What do you think?

Although there ARE opportunities for yield gain in tax-free securities these days, most people will find that the gains, if any, are slim unless you go out the yield curve and take the risk of longer maturities.

With a federal income tax bracket of 25 percent and the relatively stiff California state income tax rate on top of that you should be a good candidate for choosing tax-free income. But an examination of current money market fund offerings shows that isn't the case.

Take the money market funds offered by Charles Schwab as an example. Currently, you can get a 2.30 percent 7-day yield with their taxable fund that requires a $25,000 initial deposit and a maximum 1.50 percent 7-day yield on their highest yield tax-free money market fund. So your yield is 35 percent less. The only money you could spend would be the difference between your combined federal and state income tax rate and that 35 percent.

In California, a taxable income over $40,346 is subject to a tax rate of 9.3 percent so it's a good bet that your combined tax rate is 34.3 percent. So your move to a tax-free account would gain you 7/10ths of 1 percent a year. That would be about $175 on a $25,000 balance account. That's not chicken feed but it probably won't change your life and you need to scale up your money market account to $25,000 just to be eligible.

Scott

Actually, the question was more about opening a new asset class (category? I'm not sure what to call it.) My wife and I each have a Roth IRA, a traditional IRA, an unmatched 403(b). I have a matched 403(b), my wife has CalSTRS. I have Social Security and my wife has this weird annuity from work (a topic for another time). We fund a Coverdell account, we have checking accounts, a taxable bond fund, taxable domestic stock fund and a taxable international stock fund. Our house is paid off and we have no debt. They way I see it the only thing left is a tax-free municipal bond fund or a FDIC insured CD. Currently the INGDirect 12-month CD yields about 3.30%. The Vanguard Prime Money Market Fund yields about 2.23%. The Vanguard California Long-Term Tax-Exempt Fund Investor Shares (VCITX) yields about 4.19%. I'm not thinking of moving all the money market funds into a different account, but adding an account in a different category (class?) with new money.

 -Gary

Gary,

I think you should be cautious about lumping apples in with the oranges. The INGDirect CD has a maturity of only 12 months. The Vanguard MM fund is considerably shorter. But the maturity of the Vanguard California Long-Term Tax-Exempt Fund (VCITX) is 12.1 years. That means you're taking a lot of additional risk (interest rate risk) to get the additional return. My earlier comments assumed that you were going to stay in the same risk range in terms of maturity but seek tax-free income.

Scott