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MAXIMIZE
AFTER-TAX RETURNS
Q&A
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Why do I need to think
about maximizing after-tax
returns?
How can municipal bonds
help me maximize after-tax
returns?
What is AMT?
Are there additional
benefits associated with
investing in municipal
bonds?
Besides investing in
municipal bonds, what
else can I do to try to
protect my wealth?
Q
: Why do I need to think about maximizing after-tax returns?
With higher taxes on investment income and bond prices under pressure from rising
interest rates, you may be concerned about your fixed-income investment’s ability to deliver
the income you need to reach your financial goals. One strategy to help you keep more of
what your investments earn is to examine the tax efficiency of your portfolio.
You may think of tax-efficient investing as a strategy geared toward high-net-worth investors,
but let’s face it — taxes add up for everyone. The goal of tax-efficient investing is not to avoid
taxes. It is to maximize the after-tax return of an investment portfolio that is built around your
individual needs, risk tolerance and time horizon.
Q
: How can municipal bonds help me maximize after-tax returns?
Many investors don’t realize the negative effect taxes can have on long-term portfolio
performance. The potential benefits of investing in municipal bonds are significant, regardless
of your income level. While interest earned on taxable fixed-income investments, such as
corporate bonds and Treasuries, is taxed at the investor’s ordinary income tax rate, interest
earned on municipal bonds is generally exempt from federal taxes — which means you keep
more of what you earn. State taxes may apply to your municipal bond income, depending on
the fund and your state of residence.
For the two municipal investment categories in the chart below, the added yield afforded by
their tax-exempt status is indicated in the blue portion of the bar. Although taxable municipal
bond yields may appear higher in some cases, once you factor in the taxes on that income,
the tax-exempt options begin to look better.
Muni bonds: Attractive taxable-equivalent yields (%) as of 09/30/151
U.S. Treasury (10-year)
2.04
Corporate investment
grade bond
3.42
Muni broad index
2.18
Corporate high yield
8.04
Muni high yield index
6.81
0
2.04%
3.42%
1.67 3.85%
8.04%
12.03%
5.22
2
4
Stated yield
6
8
10
12
14
Tax benefit
Source: Bloomberg (U.S. Treasury 10-year) and Barclays as of 09/30/15
1
Taxable equivalent yield = stated yield divided by (1-.434). This assumes a 43.4% tax rate, the top federal income tax rate of 39.6%
plus the federal 3.8% tax on net investment income, and no state taxes.
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Congressional gridlock will no doubt delay any significant tax reform until after the next
presidential election. As such, the tax hikes enacted in recent years are likely to remain
in place at least through 2016. The tax-exempt interest income municipal bonds distribute
can be very attractive in an environment where investors are constantly looking for higher
yielding options.
As an investor, you cannot control interest rates or tax increases. However, by choosing
mutual funds that invest in municipal bonds, you could significantly improve the diversification
and after-tax income potential of your portfolio.
Q
: What is AMT?
AMT stands for alternative minimum tax, and it eliminates many itemized deductions for
millions of U.S. taxpayers. By disallowing certain deductions under the regular tax system,
AMT increases the amount of income that is subject to taxation. Though the tax was originally
intended to prevent high-income earners from using excessive tax exemptions, more and
more, average-income individuals are finding themselves subject to AMT.
Some municipal bond funds distribute income that is subject to AMT, and some municipal
bond funds are AMT-free. If you are subject to AMT, you may want to consider AMT-free bond
funds to help reduce your taxes.
Q
: Are there additional benefits associated with investing in municipal bonds?
Financial planning often presents a dilemma for socially conscious investors. You care
deeply about your community, the environment and the welfare of others, but you also want
to reach your financial goals. You need an investment option that prioritizes both doing well
(financially) and doing good (for the community).
By investing in municipal bonds — bonds created to serve the public good by improving
infrastructure, building schools and hospitals, and providing affordable housing, for example
— you may be able to contribute meaningfully to local communities without compromising
your investment goals.
Q
: Besides investing in municipal bonds, what else can I do to try to protect
my wealth?
Choosing tax-efficient investments is only the first step. The potential benefits of municipal
bonds increase when asset location is part of your overall strategy. Asset location is all about
how you divide investments between your taxable and tax-deferred accounts. Generally, taxefficient investments like municipal bond funds are best placed in taxable accounts, while
less tax-efficient holdings like taxable bond funds are typically held in tax-deferred accounts
such as an IRA or 401(k). Your financial advisor can help you create an asset location
strategy that’s right for you.
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The chart below illustrates the importance of choosing the appropriate asset location for your
investments. Suppose an investor, John Dough would like to put $200,000 in a taxable bond
fund for a period of 20 years. Let’s assume that his federal tax rate is 36.8% and he will be
earning an annual rate of 6% before taxes on the investment. Which type of account should
John choose for his investment? If he chooses a tax-deferred IRA, the amount he gets at the
end of the 20-year period after liquidating the investment and paying applicable taxes could
be almost $58,000 more than the liquidation value from a taxable account.
Some important things to keep in mind:
Tax-deferred accounts are still subject to taxes upon withdrawal. The $58,000 difference
in the example represents the advantage of 20 years of compounded accruals in the taxdeferred account, even after taxes are deducted.
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Since municipal bonds and funds that invest in them are already tax-advantaged and
distributions from tax-deferred accounts are taxable, placing them in a tax-deferred account
would generally not be in an investor’s best interest. Consult with your financial advisor to
determine your best strategy for asset location.
20-year returns in taxable account vs. tax-deferred IRA
700,000
$641,427
600,000
Value ($)
500,000
$421,025
400,000
300,000
200,000
100,000
0
1
2
3
4
5
6
10 11 12 13 14 15 16 17 18 19 20
Years
Taxable account
Tax-deferred IRA
7
8
9
Source: Columbia Management Investment Advisors, LLC
Diversification strategies are becoming increasingly complex. Maintaining a fixed-income
component in your portfolio is a good start, but by employing a tax-exempt strategy in
the form of municipal bonds, or mutual funds that invest in them, you can help minimize
the erosive effects of taxes on your portfolio. Keep more of your hard-earned savings.
You deserve it!
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About Columbia Threadneedle Investments
Columbia Threadneedle Investments is a leading global asset management group that provides a broad range of actively managed
investment strategies and solutions for individual, institutional and corporate clients around the world.
With more than 2,000 people, including over 450 investment professionals based in North America, Europe and Asia, we manage $471
billion* of assets across developed and emerging market equities, fixed income, asset allocation solutions and alternatives. We are the
13th largest manager of long-term mutual fund assets in the U.S.** and the 4th largest manager of retail funds in the U.K.***
Our priority is the investment success of our clients. We aim to deliver the investment outcomes they expect through an investment
approach that is team-based, performance-driven and risk-aware. Our culture is dynamic and interactive. By sharing our insights across
asset classes and geographies, we generate richer perspectives on global, regional and local investment landscapes. The ability to
exchange and debate investment ideas in a collaborative environment enriches our teams’ investment processes. More importantly,
it results in better informed investment decisions for our clients.
To find out more, call 800.426.3750
or visit columbiathreadneedle.com/us
*In U.S. dollars as of September 30, 2015. Source: Ameriprise Q3 Earnings Release. Includes all assets managed by entities in the Columbia and Threadneedle groups of companies. Contact
us for more current data.
**Source: ICI as of September 30, 2015 for Columbia Management Investment Advisers, LLC.
***Source: Investment Association as of September 2015 for Threadneedle.
Columbia Threadneedle does not offer tax or legal advice. Consult with a tax advisor or attorney.
Diversification does not assure a profit or protect against loss.
Columbia Threadneedle Investments (Columbia Threadneedle) is the global brand name of the Columbia and Threadneedle group of companies.
Columbia funds are distributed by Columbia Management Investment Distributors, Inc., member FINRA, and managed by Columbia Management Investment Advisers, LLC.
Columbia Management Investment Distributors, Inc., 225 Franklin Street, Boston, MA 02110-2804
© 2016 Columbia Management Investment Advisers, LLC. All rights reserved. CT-MK/112287 C (02/16) 15VN/1406249