What Is Tax-Exempt Money Fund?

A Tax-Exempt Money Fund, also known as a tax-free money market fund, is an investment vehicle designed to provide investors with income that is exempt from federal (and sometimes state) taxes. These funds invest primarily in municipal bonds and other tax-exempt securities, making them an attractive option for individuals in higher tax brackets looking to maximize their after-tax income.

Pros of Tax-Exempt Money Fund

Tax Savings

The primary advantage of Tax-Exempt Money Funds is the tax-free income they generate. For investors in higher tax brackets, the tax savings can be significant, making these funds more attractive than taxable alternatives.

Low Risk

Tax-Exempt Money Funds are generally considered low-risk investments. They invest in high-quality, short-term municipal securities, which are known for their stability and low default rates. This makes them a relatively safe choice for conservative investors.


These funds offer high liquidity, meaning investors can easily access their money when needed. This feature makes them an excellent option for individuals looking to park their cash temporarily without sacrificing accessibility.


Investing in a Tax-Exempt Money Fund provides diversification across various municipal securities. This helps spread risk and can lead to more stable returns compared to investing in a single municipal bond.

Cons of Tax-Exempt Money Fund

Lower Yields

One of the main drawbacks of Tax-Exempt Money Funds is that they tend to offer lower yields compared to taxable money market funds. This is because the tax advantage is already built into the yield, making them less attractive to those in lower tax brackets.

Interest Rate Sensitivity

These funds can be sensitive to changes in interest rates. When interest rates rise, the value of the underlying municipal bonds may decrease, potentially leading to lower returns for investors.

State Tax Considerations

While income from these funds is typically exempt from federal taxes, it may still be subject to state taxes unless the fund specifically invests in securities from the investor’s home state. This can reduce the overall tax benefit for some investors.

Limited Growth Potential

Tax-Exempt Money Funds are designed to provide steady income rather than capital appreciation. Investors seeking significant growth might find these funds less appealing compared to other investment options like stocks or real estate.


Tax-Exempt Money Funds can be a valuable addition to an investment portfolio, particularly for individuals in higher tax brackets seeking to minimize their tax liability. They offer the benefits of tax-free income, low risk, high liquidity, and diversification. However, investors should also consider the potential downsides, such as lower yields and sensitivity to interest rate changes. As with any investment, it’s essential to assess your financial goals and risk tolerance to determine if a Tax-Exempt Money Fund is the right choice for you.