Don’t Use Tax Advantaged Investments in 401K, IRA

Given the recent Supreme Court ruling that upheld the tax advantaged status of investments such as municipal bonds, you may be tempted to begin investing in these instruments. If you do, don’t invest in them through a 401K or an IRA (either Roth or Traditional). You want to take full advantage of their tax advantaged status by investing in them in a fully taxable brokerage account.

The benefit of municipal bonds is that they are exempt from federal, state and local income taxes if they meet certain qualifications. If you live in Maryland and purchase a Maryland municipal bond, then those earnings are exempt from federal, state, and local income taxes – thus pushing up its yield (because you’d be paying taxes on the earnings of any other investment).

If you invest in those types of securities in a 401K, you lose the tax exempt status because you ultimately pay taxes on distributions in the 401K (the same for a Traditional IRA). If you invested in a Roth IRA, you are still exempt but all appreciation in a Roth IRA is exempt from taxes. You are essentially no longer getting the same advantage and thus not maximizing your yield.