Originally posted Wednesday, April 20, 2016
With the 2015 Tax Filing deadline now in the rear view mirror, many individuals, especially those who had to pay significant Federal or State tax, are thinking through ways that they might do things differently and minimize the painful tax bite in the future.
Although many investors have the majority of their retirement nest eggs in qualified retirement accounts – IRAs, 401ks, 403bs and pensions where earnings are deferred from tax until withdrawn, there are others who desire to or already have build up additional after tax investments to be used as a supplemental source of retirement income in the future.
With bank savings account interest rates still at historic lows, leaving large sums beyond what is needed for emergency or cushion funds doesn’t make sense. On the other end of the spectrum, if an individual has large sums in after tax accounts holding mutual funds, stocks and exchange traded funds, the taxable income that is distributed from these investments can be a significant negative surprise when the year- end 1099s are distributed.
An investment alternative many people are often unaware of is municipal bonds. Municipal bonds distribute income that is federally tax free. The income may also be state and local tax free if the bonds owned are issued within their state or city of residence. In addition to owning individual municipal bonds, there are a myriad of mutual funds that own portfolios of municipal bonds to diversify among municipal issuers.
Many people who are aware of municipals think of them as an investment primarily for older individuals or the very wealthy. But both nationwide and in our practice, many younger and moderate income individuals have become investors in municipals in recent years.
Another reason that younger generations have also embraced municipals is that they increasingly want to see their investments as socially responsible.
Municipal bonds fit this need. For good reason—broadly, the projects financed by municipal bonds are for essential public purposes such as, hospitals, affordable housing, senior care, public transportation, water and sewer, bridges and tunnels.
Bond proceeds provide needed jobs during project construction and long-term jobs afterwards to maintain the services. In the long term, the community gets health care, places to live, clean water and better transportation. Investors in the bonds, individuals or institutions, get a steady income stream from the interest payments on the bonds.
People in retirement tend to take their income in cash and individuals saving for retirement reinvest their interest or dividends to provide for both growth of principal over the long term and ultimately increased income in retirement.
If you would like to discuss whether municipal bonds should be part of your portfolio, give us a call so we can discuss your situation in detail and the potential benefits that municipal bonds may provide you.
Municipal bonds are federally tax-free but may be subject to state and local taxes, and interest income may be subject to federal alternative minimum tax (AMT). Bonds are subject to availability and market conditions; some have call features that may affect income. Bond prices and yields are inversely related: when the price goes up, the yield goes down, and vice versa. Market risk is a consideration if sold or redeemed prior to maturity.