Staggering CD maturity dates is safe, simple option for your nest egg


Q: My husband and I are divorcing after 24 years of marriage. Our home is up for sale, and when it is sold, we will be dividing the proceeds.

The balance owing on our land contract added to back taxes for the past two years comes to approximately $8,000. When these expenses are paid, I hope to be receiving approximately $50,000 as my share of the proceeds.

I have talked to my bank trust officer, and he indicated that at the time I receive the proceeds, he will be willing to advise me on investments. My sister is advising me to retain an investment counselor, and my folks are telling me the best investment is municipal bonds. Needless to say, I am getting advice from everyone.

This money will be for my retirement, so I want to invest it the best way possible. What are your suggestions regarding investments and financial planners? Any advice you can offer would be greatly appreciated.

A: This money is your nest egg, and it will play an important role in your future security. The first thing I advise you to do is immediately contact your state treasurer to find out your state's policy on back taxes. It sure would be tragic if your house is repossessed by the state and auctioned off for nonpayment of back taxes.

The situation could be further complicated by the conditions and provisions of your land contract. Depending on the wording, the house may technically belong to the holders of the land contract. Under the worst-case scenario, they might be the beneficiaries of any excess proceeds from the auctioning of the house. So, before worrying about investing the profits, make sure those profits are secure by taking care of the back taxes.

As to investing the proceeds, I advise you to keep half the money safe in simple investments, like inflation-proof certificates deposit (sometimes called bump-up CDs) or two-year to five-year Treasury notes. You may also want to stagger maturities by buying investments with different maturities. For example, put $5,000 in a one-year CD, $5,000 in a two-year CD, etc.

I doubt that you will be in a high enough tax bracket (31 percent or above) to justify the lower yield of municipal or tax-exempt bonds.

The other half of the proceeds should be invested in well-diversified domestic and international stock mutual funds -- preferably no-load ones.

If managing investments on your own scares you, look for a fee-only financial adviser -- one who does not profit by the advice given. For a free referral, contact the National Association of Personal Financial Advisors, 1130 Lake Cook Road, Suite 105, Buffalo Grove, Ill., 60089, or call (800) 366-2732.

Q: You mention tax brackets a lot in your columns. Can you please explain what they are? My gross income last year was $41,500, and my taxable income was $27,118.

How do I figure out my tax bracket, and what are the practical implications of knowing my tax bracket?

A: A tax bracket is another name for a tax rate. The federal government charges progressively higher tax rates on income. As your taxable income increases, so does the tax rate you pay on your top dollars of earnings.

Here's how it works: There are five tax brackets: 15 percent, 28 percent, 31 percent, 36 percent and 39.6 percent. A single filer with one exemption pays a 15 percent federal tax on up to $22,750 of taxable income. On earnings between $22,750 and $55,100, a 28 percent rate is charged; between $55,100 and $115,000, there is a 31 percent rate; between $115,000 and $250,000 of taxable income, a 36 percent rate is levied; and a 39.6 percent rate applies to taxable income over $250,000.

Although your top dollars of income are in the 28 percent tax bracket, your federal tax for this year will only be 17.09 percent ($4,636) of your total taxable income of $27,118 -- assuming your earnings will stay the same as last year. On the first $22,750 of your income, a 15 percent tax would be levied ($3,413). Add to that 28 percent of the remaining $4,368 ($1,223), for a total of $4,636.

A married couple filing jointly with two exemptions pays 15 percent on up to $38,000 of taxable income. Earnings between )) $38,000 and $91,850 are taxed at 28 percent; between $91,850 and $140,000, there is a 31 percent tax; between $140,000 and $250,000, a 36 percent rate applies; and a 39.6 percent rate is charged on taxable income over $250,000.

Your top tax bracket -- the tax rate on your highest dollars of earnings -- is important to know for at least two reasons: to calculate after-tax investment gains and interest, and to know the true cost of tax-deductible loans like a mortgage on your home.

Here are two examples:

Investments: If you own a 7 percent certificate of deposit (CD) that is fully taxable, after taxes you'd be left with: 5.95 percent at the 15 percent tax bracket; 5.04 percent at the 28 percent; 4.83 percent at the 31 percent; 4.48 percent at the 36 percent; 4.23 percent at the 39.6 percent.

As you can see, the return on your investment varies widely among the different tax brackets. State and local income taxes further reduce after-tax yields.

Mortgage: Assume your mortgage payment comes to $1,100 a month, of which $1,000 is interest. Since mortgage interest is deductible, your tax bracket will affect your bottom-line cost.

At the 15 percent tax rate, your mortgage interest will cost $850, so your real mortgage cost is $850 plus $100 of principal, or $950 month.

At the 28 percent bracket, the mortgage interest will cost you $720 after tax, and your total mortgage cost will be $820 a month.

At the 31 percent bracket, the mortgage interest will cost $690, and your real mortgage cost will be $790.

Given your taxable earnings of $27,118, you have $4,368 on which you pay a 28 percent federal tax, since you only pay 15 percent on your first $22,750 of income. If your taxable earnings remain the same as they were last year, you will be able to save 28 percent on your first $4,368 of mortgage interest.

Armed with an understanding of tax brackets, you can make more informed decisions about a large array of financial matters.

Susan Bondy founded her namesake financial services company in 1980 to provide financial planning and asset management. She is the author of "How to Make Money Using Other People's Money." Write to Susan Bondy in care of The Sun, 501 N. Calvert St., Baltimore, Md. 21278. All letters will be treated confidentially.

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