Tax FREE Money Market Mutual Funds - MUNIs

Nov 05, 2013: Most astute investors are aware of municipal mutual funds also known as MUNIs. These funds invest in term debts issued by various state and local governments. In general dividends and gains from muni funds are exempt from federal as well as state taxes.

One has to be a domicile of a particular state to invest in a state specific money market fund. Thus muni funds provide a way to reduce our tax liability. It is a great investment vehicle for those of us who are in high federal and high state income tax brackets. So far so good. Unfortunately this strategy may not be suitable for all.

Not for everyone

If any of the following situation is applicable to us then we would need a different strategy:

• No income tax imposed by state - WOW! Yes residents of the following states are the lucky ones: Alaska, Florida, Nevada, South Dakota, Texas, Washington and Wyoming.
• There is no state specific money market fund that is worthwhile to invest in.
• The state charges income tax only on dividend and interest income. There are only two such states, New Hampshire and Tennessee.

Alternative Strategy

Well hope prevails. For those of us who are in the above situation, it may be wise to consider investing in national money market funds whose dividends are federally non-taxable. However, we may have to pay state taxes depending on which state we reside.

Choices for Muni Funds

Among available choices for MUNI we would like to highlight three muni funds. We chose them because of their good reputation, high yield and most importantly, low expense ratios. Mostly we have considered short term muni funds.

Vanguard Tax-Exempt MMF - VMSXX

• 10 year average annual returns: 1.35%
• Expense ratio: 0.16%
• Minimum investment: $3000

American Century Tax-Free MMF - BNTXX

• 10 year average annual returns: 1.22%
• Expense ratio: 0.50%
• Minimum investment: $2500

T. Rowe Price Tax-Exempt Money - PTEXX

• 10 year average annual returns: 1.12%
• Expense ratio: 0.51%
• Minimum investment: $2500

In case we need to put aside a huge sum of money (which is liquid and accessible) for a short while then Fidelity's nontaxable muni fund is a good choice. Please note that the minimum investment is $25,000.

Fidelity AMT Tax-Free Money Fund - FIMXX

• 7 day effective yield: 1.20%
• Expense ratio: 0.43%
• Minimum investment: $25,000

Do you invest in nontaxable money funds? Let us know which one is your favorite and why so. For others now maybe a good time to estimate your annual taxes and consider saving some moolah by investing in a MUNI. All the best!

Image Source(s): iStockPhoto

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