If you invest in a mutual fund that is a bond fund that is inside your 401k - do you benefit from not paying taxes on the coupons of the bond? I mean how are you treated as a fund holder differently than someone that invests in the fund but owns the fund outside of their 401k. I'm trying to realize what the tax advantage is (if any) to holding a bond mutual fund in a 401k. Thanks.
snipped-for-privacy@yahoo.com (John) posted:
The bond fund would be an investment within the 401k, which is sheltered from current taxation. That is the sole extent of the benefit.
I _think_ the answer would be clear, if you had bought a bond fund circa 1980 when the prime nudged 20% and tax-free municipals were yielding 12%. Those funds which had acquired non-callable bonds -- such as 30-year US Treasuries at > 9% -- enjoyed a huge increase in value. Of course, the LT capital gains advantage wouldn't apply to distributions from the 401k (or its successor, likely a rollover traditional IRA), but it would still add a great deal of value. Today's bond yields don't seem to allow for that kind of satisfaction -- but I suppose when Japan's official rate went to -0-, _all_ Japanese bonds benefited ... so anything is possible. Bill
When you own the fund in a taxable account you pay tax when the interest is distributed from the fund. When you own it in a retirement account, you don't pay until you withdraw the funds in retirement.
There is no advantage other than the above. What you want to be careful of is investing within a retirement account in funds that hold tax-exempt bonds. That has the effect of turning non-taxable interest into taxable income.
-- Phil Marti Clarksburg, MD
The benefit is that federal income tax is deferred until you ultimately take distributions from the 401K. This way, extra earnings can accumulate by earning earnings on what would've gone to the IRS a lot sooner.
You never pay taxes on securities held within a 401k or IRA. The earnings are accumulated in the retirement account (in the case of a 401k, I've never been given the option to do anything other than automatically reinvest them, although this is immaterial to this discussion). You pay taxes when you ultimately withdraw from the account (except for Roth IRAs). So the tax advantage is that the taxes are *deferred*. This allows you to reinvest more of the earnings, so it compounds more. And if you're in a lower tax bracket when you withdraw, you pay less taxes in the long run.
-- Barry Margolin, snipped-for-privacy@alum.mit.edu Arlington, MA
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