FINRA Series 7Investment Information and Suitable RecommendationsHard
A client in a high tax bracket owns a portfolio of income-generating securities and is seeking to reduce their current taxable income. Which of the following investments would be MOST suitable for this objective?
- APreferred stock
- BZero-coupon municipal bond
- CGrowth mutual fund
- DTreasury bond
Show answer & explanationAnswer & explanation
Correct answer: B. Zero-coupon municipal bond
Zero-coupon municipal bonds are particularly suitable for clients in high tax brackets seeking to reduce current taxable income. The interest (accreted value) is exempt from federal income tax and potentially state/local tax, and it is not paid out annually, thus avoiding 'phantom income' that would be taxable with corporate zero-coupon bonds.
Why the other options are wrong
- A. Preferred stock pays qualified dividends, which are taxable at preferential rates, but still add to current taxable income.
- C. Growth mutual funds typically aim for capital appreciation, not income, and any dividends/capital gains are taxable.
- D. Treasury bonds pay taxable interest at the federal level, though exempt from state/local.
Zero-Coupon Municipal Bond Suitability
Zero-coupon municipal bonds are suitable for investors in high tax brackets who want tax-exempt income and do not need current cash flow, as they avoid 'phantom income' tax issues common with taxable zero-coupon bonds.
- Interest is tax-exempt (federal, potentially state/local).
- No annual cash payments (zero-coupon).
- No 'phantom income' tax liability like taxable zeros.
- Good for future lump sum needs (e.g., college, retirement).
Memory trick: Zero-Muni: Zero Tax, Zero Annual Payout, Zero Phantom.