Investors piled cash into money market mutual funds in 2023 and now could see a higher tax bill (2024)

FAQs

How are money market mutual funds taxed? ›

The earnings from money market funds can come from interest income or capital gains, so they're taxed the same way as other investment income.

Short-term capital gains (assets held 12 months or less) are taxed at your ordinary income tax rate, whereas long-term capital gains (assets held for more than 12 months) are currently subject to federal capital gains tax at a rate of up to 20%.

Income earned from money market fund interest is taxed as regular income, up to 37% depending on the investor's tax bracket. While some local and state taxes offer breaks on income earned from U.S. Treasury bonds, federal income tax still applies.

Indirectly losing money, however, is a downside of money market accounts. Indirect loss can occur if the interest rates tied to the account fall, thus diminishing the initial return value of your account.

Some disadvantages are low returns, a loss of purchasing power, and the lack of FDIC insurance. A money market fund can be ideal in some situations and potentially unwise in others. If you're close to or in retirement and need some of your money soon, a money market fund can make sense.

Because they invest in fixed income securities, money market funds and ultra-short duration funds are subject to three main risks: interest rate risk, liquidity risk and credit risk.

Just as with individual securities, when you sell shares of a mutual fund or ETF (exchange-traded fund) for a profit, you'll owe taxes on that "realized gain." But you may also owe taxes if the fund realizes a gain by selling a security for more than the original purchase price—even if you haven't sold any shares.

The simplest way to avoid this is to own mutual funds in tax-advantaged retirement accounts such as IRAs and 401(k)s. You can also make sure to hold the investments for the long term, so that if you do owe taxes, you'll pay them at the lower long-term capital gains rate.

Rather than more favorable capital gains rates, you'll owe regular income taxes on money market fund earnings, with a top bracket of 37%. By comparison, the top long-term capital gains rate is 20%.

Because you earn higher interest rates than with a traditional savings account, a money market account can be a great choice to set aside some emergency cash or start building your savings. And unlike a traditional savings account, you have more options for withdrawing your money when you want it.

Should I move my money into a money market account? ›

When saving for a financial goal, it's important to make sure you're utilizing the most beneficial investment type for your goal based on its time horizon. Money market funds make the most sense for short-term goals and generally should not be used for long-term investing, such as retirement.

The interest you earn in a money market account is taxable as regular income. Reporting money market interest on your federal tax return is simple: Grab your 1099-INT form(s) and your Form 1040 to get started.

A money market fund is a type of investment account that invests in funds that may gain and lose value, meaning you could lose part of your initial investment.

Both money market accounts and money market funds are relatively safe, low-risk investments, but MMAs are insured up to $250,000 per depositor by the FDIC and money market funds aren't.

Money market funds are usually considered to be safe investments, but it's important to remember that these investments are intended for the short term. With maturities of 13 months or less, the funds stay liquid and allow you better access to your money than longer-term investments.

Municipal money market funds invest primarily in short-term, municipal money market securities issued by states, local governments, and other municipal agencies. They pay interest that is generally exempt from federal income tax.

How dividends are taxed is very important when considering investments for cash flow. Interest from money markets, bank CDs, and bonds is taxed at ordinary tax rates. That means a person in the top tax bracket pays taxes on interest payments up to 37%.

Capital gains distributions are paid by mutual funds from their net realized long-term capital gains and are taxed as long-term capital gains regardless of how long you have owned the shares in the mutual fund. Mutual funds may keep some of their long-term capital gains and pay taxes on those undistributed amounts.

How safe are money market funds? There is little risk associated with money market funds. The U.S. Securities and Exchange Commission (SEC) mandates that only the highest-credit-rated securities are available in money market funds.