You are examining two different MMMfs. Fund A is tax-exempt and pays 7%. Fund B is taxable and pays 9.5%. You live in a state that imposes no income taxes and you are in the 25% federal tax bracket. Which of these two alternatives is better?

Question

Quizplus · Accepted Answer

Since you live in a state with no income taxes, there is no advantage to choosing the tax-exempt fund. However, you are in the 25% federal tax bracket, which means that the taxable fund will have an after-tax return of 7.125% (i.e. 9.5% * (1 - 0.25)). This is still higher than the tax-exempt fund's return of 7%. Therefore, Fund B is the better choice.

You Are Examining Two Different MMMfs