Investors Who Piled Cash into Money Market Funds May See Tax Bill Surprise

December 2, 2023

Amid rising interest rates, many investors funneled cash into money market mutual funds in 2023, which may make for an unexpectedly large tax bill in April.

Investors and institutions have piled $5.84 trillion into money market mutual funds as of the end of November, according to the Investment Institute Company. Not to be confused with money market deposit accounts, money market mutual funds are mutual funds that typically invest in shorter-term, lower-risk debt, such as U.S. Treasury bills. The recent climb in interest rates and Treasury yields means that some funds are paying more than 5%, which has attracted investors but may also mean a higher-than-expected tax bill.

Rather than more favorable capital gains rates, money market mutual fund earnings are taxed as regular income, with the top tax bracket being 37%. By comparison, the top long-term capital gains tax rate is 20%. For example, take an investor in California with a combined federal and state tax rate of 45%. Having $100,000 in a money market fund earning 5% could result in a tax bill as high as $2,250. 

Luckily, some states offer a tax break depending on the underlying assets within the fund. Money market funds the U.S. Treasury bonds may exclude a portion of earnings from state and local taxes, for example. Still, many investors may not find out about the tax implications of their money market fund earnings until they receive tax forms in early 2024.

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