Tax Shelther a Short Term Mutual Fund account?

Question

Tax Shelter a Short Term Mutual Fund account?
I am 72 years old and I want to put down $10,000 to start a Short-Term(2-5 year) account, with divided reinvested to buy more shares. I hear that even though the dividends are reinvested, dividends reinvestment are considered taxable income for that year and I will have to pay at the end of the year. Is this information correct?

If so, how else would a be able to direct the dividends so that I be tax sheltered from govn't hands. Would I be able to direct earnings into an IRA, but only $4000 is allowable for IRA, is there other ways to not get taxed on my Mutual Fund divideds and earnings? Annuity? Life Policy? LTC?

Answer 1

You are correct. Dividends are taxed whether they are reinvested or withdrawn.

A municipal bond fund pays dividends that are exempt from Federal tax and MAY be exempt from state tax depending as to what state you are in.

Don't let tax consequences be the primary driving force from which investment you choose though. I would rather get a 12% return from a taxable account than a 4% return from a non-taxable one.

Answer 2

With inflation that's a moderate risk investment; although just a year is not a lot of time and it'd be far better if you could keep it for longer if things don't do well. With a CD, money market fund or short term bond fund you are probably losing money with inflation factored in. The latter is best though if you are more risk averse. Otherwise, you could try a intermediate term bond fund - the scaremongering about hyperinflation has been going on for over 3 years now. Could it happen? Sure, but not too likely. If anything, economic malaise will continue.

Answer 3

Since you are over the age of 70.5, you are no longer eligible to contribute to a traditional IRA. If you have earned income, such as wages or from self-employment, you are allowed to contribute $5,000 per year into a Roth IRA.

You are correct about the treatment of dividends. Even though they are reinvested, the mutual fund will declare them every year and send you a 1099DIV. You will declare those dividends and pay a maximum tax of 15%, assuming these are "qualified" dividends which they most likely are.

So, you cannot direct your dividends into a traditional IRA, but possibly into a Roth IRA if you qualify. If you choose to purchase long-term care insurance, that is a deductible expense. If you have medical deductions anyway, the purchase of LTC insurance by using your dividends essentially gives you tax-free LTC insurance premiums.

If you use the proceeds of your investment to purchase an annuity or life insurance, these are not tax deductible but do have tax-deferral.