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In a taxable investment account, your capital
gains and investment income are subject to taxation in the year they are
earned. In a qualified tax-deferred account such as an IRA or some college
savings account, income and capital gains are not taxed until you start
taking withdrawals, presumably at a future date.
Bonds and bond funds can be held in either type of account, but some
investors will have a reason to choose one account type over the other.
Municipal investments, for example, are best held in a taxable account,
where they can serve to reduce the taxable returns. Taxable zero coupon
bonds are best held in a tax-deferred account because their annual interest
credits are taxable when earned, even though the investor does not actually
receive them until the bond matures.
Since the maximum tax on capital gains was reduced to 15% in 2003, total
return investors in a high income tax bracket may find advantages to holding
their bonds in a taxable account. Others may prefer to invest for maximum
income in their tax deferred accounts. The best solution depends on your
individual circumstances and tax situation. Your tax or investment advisor
can help you analyze the alternatives and reach the best solution.
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