Weighing a CD
To the Editor:
In the article “A Time for Time Deposits” (by Gilkeson, Porter and Smith, December 2010 AAII Journal), the authors state that investors should use their marginal tax rate instead of their average tax rate. Why not use the effective tax rate instead? Using the effective tax rate would allow investors to adjust for their unique circumstances—presuming minimal changes between years. If there is a big change, this obviously would not apply, and investors would use the marginal rate unless they could effectively determine their new effective tax rate.
James Gilkeson Responds:
When making a single investment decision—in this case, deciding whether to invest in a bank CD or a same-maturity U.S. Treasury security—the proper question to ask is what the income (net, after all costs and benefits, including taxes) from each alternative will be. For taxable income (the CD interest), this net or marginal income will be measured using the marginal tax rate paid by the investor, not the average tax rate, because additional dollars of income are taxed at the marginal rate, not the average rate.
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