Now, let’s say that the couple’s fixed income portfolio consists of tax-advantaged municipals, specifically the iShares National AMT-Free Muni Bond Fund (MUB), rather than taxable bonds. Considering that the interest income on munis is tax-exempt, how would the couple’s tax situation differ?
First, we need to adjust for the lower dividend yield of MUB versus CIU to determine the new interest income amount. Once you take the principal and multiply it by the distribution yield of 3.08%, instead of getting $36,000 of interest income, the couple only gets $35,088 However, because tax-exempt income doesn’t count when you compute the surtax threshold, the couple’s total income for purposes of the surtax is now only $180,000+$54,000 or $224,000, which means that now the surtax won’t apply at all. What that means is that on an after tax basis, the couple ends up with about $80,988, rather than $71,820.
The way I computed it, in the muni scenario, the couple still pays $8,100 on the equities but they pay nothing on the fixed income. So although the couple’s pretax income would be $89,088 rather than $90,000, on an after-tax basis, the couple keeps more.
To be sure, I computed these scenarios on a plane without a ton of research and I used a lot of short cuts and assumptions (check my math and let me know what I’m missing in the comments section below). And everyone’s tax situation is unique, so it’s important to discuss your tax situation with your own tax professional.
Still, my rough example does show how important it is to consider the tax implications of various investment options in the post-fiscal cliff deal, post-Obamacare world. The last time I checked, $9K is still a nice sum. In fact, some claim you can live on even less than that.
Sue Thompson, CIMA, is the iShares Head of Registered Investment Advisor Group.