A tax exempt bond fund recently solicited investment by retirement plans. Under present tax laws, all contributions to qualified retirement plans are tax exempt until withdrawn and all retirement plan money is subject to taxation upon distribution at the ordinary income rate, which is a higher rate than the earned income rate. So, including tax exempt investments in retirement plans has no advantages and has the great disadvantage of losing the tax exempt status of the investment in the end.
The only investments that should be considered for retirement plan money are those which entirely or primarily increase in value through yield (interest and dividends) and/or short term capital gain. Yield will be taxed as ordinary income outside a retirement plan, but it is not so taxed in a retirement plan until withdrawn; and, therefore, can pyramid tax-free until withdrawn. Short term capital gains are taxed at the highest rate outside a retirement plan, but are not taxed within the plan, and are taxed at the ordinary income rate when withdrawn. Investments which are primarily aimed at long term capital gain (such as artwork, gemstones, gold, silver, stamps and coins, and most real estate) belong outside of retirement plans. They can still be made, by borrowing the funds from the retirement plan and paying the plan interest, which shelters additional pretax dollars; and which preserves the low long term capital gain tax rate. The same investments, when made within a retirement plan, will be taxed at the much higher ordinary income rate upon distribution.
