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Safe savings for now

Chris Farrell Apr 27, 2010

Question: In May 2009, I sold some real estate and the proceeds were significant (over $100K). I wanted to use the money for a downpayment on another real estate purchase but I ended up getting laid off in November. Qualifying for mortgage is unlikely without a full-time job. It might be 6 months to a year before a secure another position. I stashed the money in a CD. How can I avoid a tax burden and get a decent return on the money while waiting to get back on track to a real estate purchase? Sharon, San Francisco, CA

Answer: It’s very difficult to get a decent rate of return on a safe asset in the current interest rate environment.

Savers are getting pennies for their cash while policymakers direct hundreds of billions of dollars toward shoring up the banking system. However, since your unemployed (although hopefully you’ve gotten a job) you won’t pay much tax on the minimal interest you earn. That may be some small consolation.

Let’s assume for the moment that you get a good paying job. And you have a specific goal for the money: To buy another home. You don’t want to put the principal at risk. The problem with CDs is that California is a high tax state. The combined federal and state tax tab can slice deeply into yields on CDs. You might do better putting the money into comparable, short-term Treasury securities. You’ll still pay Uncle Sam on the interest but Treasuries are exempt from state and local taxes. I would stay with shorter-term maturities since I expect interest rates to go up as the recovery gathers momentum. You should run the numbers to see where you come out ahead on an after-tax basis, CDs vs. Treasuries.

Another option is parking the money into short-term California tax exempt securities. Investors have been buying high-quality general obligation bonds, which are backed by the full taxing power of California. If they’re buying revenue bonds, which are supported by fees, investors are favoring the securities backed by revenues from so-called essential services, such as water and sewer. You can easily compare what you need to earn on a taxable security to equal the tax-free yield of a municipal bond here. There are plenty of similar calculators available on the web.

My problem with the tax exempt choice is that California, the eighth-largest economy in the world, keeps flirting with fiscal disaster. That’s why I’d recommend buying Treasuries backed by the full faith and credit of the federal government if you can get a higher after-tax return than on CDs. You’ll also sleep easier knowing that the money will be there when you need it.

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