Taxing Times for Fixed Income Investors

Fixed Income, Rising Taxes

Returns on fixed income securities have risen in response to higher interest rates. But while investors are cheering, they should keep in mind what comes next: a higher tax bill.

Investors who have purchased Treasury bills, I bonds, CDs, money market funds, or municipal bonds in the past year should know how this higher yield will impact their tax bill.

Treasured Treasuries

Fixed-income investments are known for their lower risk, lower return profile compared with stock market investments. For much of the past decade, fixed-income assets hardly generated returns, making them less appealing than stocks, which jumped in the wake of the reopening of the economy following pandemic lockdowns.

But the Federal Reserve raised interest rates to combat high levels of inflation, yields rose, attracting investors back to the fixed income space. In the past five weeks, investors bought more than $90 billion worth of money-market funds, according to market data from Refinitiv Lipper. Last year, skyrocketing demand for I bonds crashed the Treasury Department website.

Filing Taxes

If you invested in any of these assets via a tax-deferred retirement plan such as an IRA or 401(k), you won’t need to worry about the tax implications. But, if you invested directly, here’s what you need to know:

•   I bonds: Income is taxed at the federal level only, and typically not until they are cashed in.

•   CDs: Interest earned on certificates of deposit is taxed as ordinary income at the federal and state level.

•   Money-market funds: There are taxable and tax-free money-market funds, and your tax liabilities will depend on what you picked.

•   Treasury bills: Interest earned on Treasury bills is taxed at the federal level, but exempt at the state and local level.

•   Municipal bonds: Income from bonds issued by state, city, and local governments tax-exempt at the federal level, as well as the state-level in the state the bond was issued.

For specific questions, consider consulting with a tax professional.

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