Is it better to put US government Treasury bond funds in an IRA or outside it?

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Request for Question Clarification by richard-ga on 09 Apr 2005 06:02 PDT

Hello
There are two ways to read your question:
1.  I am considering buying US government treasury bond funds - -
should I establish an IRA to hold them, or is that not worth doing?

2.  I currently have an IRA invested in cash/money market funds.  I am
considering buying US government treasury bond funds.  Should I use
cash that I hold outside my IRA for that purchase (and keep the IRA
funds available for some other investment) or should I have the IRA
make that purchase?

Please clarify.

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Clarification of Question by george123456-ga on 09 Apr 2005 07:34 PDT

Thank you for replying promptly.  I now have treasury bonds in an IRA.
I don't know if a tax-advantaged investment, such as treasury bonds,
should be in an IRA or outside it. George

Hello and thank you for your question.

Income from Treasury bonds is subject to federal income tax (unless
held in an IRA), but is exempt from state income tax even if owned
personally.

So if you live in a state that imposes state income tax (all do,
except Alaska, Florida, Nevada, South Dakota, Texas, Washington and
Wyoming), it would be more efficient to invest the IRA in
higher-yielding taxable bonds that if owned personally would incur
both federal and state tax.  [Of course tax exempt bonds would be the
worst choice for an IRA, much worse than the treasury bonds that you
have now.]

The extra savings of avoiding state taxes depends on the state tax
rates.  Here is a 50-state summary of tax rates
http://www.taxadmin.org/fta/rate/ind_inc.html

You'll get an extra 1/2% to 1% of yield for investment grade corporate
bonds compared to treasuries (to compensate you for their higher
risk).
http://quote.bloomberg.com/apps/news?pid=nifea&&sid=aRXu8Z2e03j4

So if your federal income tax rate is 35% and your effective state
income tax rate is 3%, an IRA invested in a corporate 4.5% bond yields
4.5%
An IRA invested in a comparable treasury bond might yield 3.75%.

Outside the IRA, the corporate bond yield is .045*(1-.35-.03)= 2.79%
compated to the treasury bond yield of .0375*(1-.35)= 2.44%

So moving the IRA from treasury bond to corporate bond increases the
yield by .75%  (and slightly increases the risk).

While moving a personal account from treasury bond to corporate bonds
increases the yield by only .35%

Search terms used:
state income tax
treasury bond corporate spread

I hope you find the above useful
Richard-ga