Should Retirees Own Tax-Free Municipal Bonds?
In this video, Ed Mahaffy explains whether retirees should consider tax-free municipal bonds and how they compare to taxable bonds and dividend-paying stocks. Learn how tax-exempt income works, when municipal bonds may be advantageous, and the key differences between municipal bond ETFs and separately managed accounts (SMAs). Ed also breaks down how taxes, fees, and account placement can impact your after-tax retirement income. If you’re a retiree or pre-retiree, understanding these tradeoffs can help you make more efficient investment decisions.
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Transcript
Should Retirees Own Tax-Free Municipal Bonds?
Should retirees own tax-free municipal bonds? If you're holding taxable bonds or dividend-paying stocks in a taxable account, you may be paying more taxes than you need to, because not all bond income is treated the same, and this can affect your after-tax income.
What Are Municipal Bonds?
Let's break it down. Tax-exempt municipal bonds are issued by state and local municipalities. The interest income is free from federal tax and sometimes state income tax as well.
Municipal Bond ETFs: Pros and Cons
Municipal bond ETFs provide liquidity and diversification, but also have some drawbacks. Dividends may be subject to state income tax. Fees can range as high as one-half of one percent. There's an inability to control capital gains taxes, and there's no stated final maturity, which can really aid in the financial planning process. And exposure to bonds subject to alternative minimum tax may adversely affect certain retirees.
SMAs vs. ETFs for Municipal Bonds
Other investors may use investment managers to manage a portfolio of individual municipals. These so-called separately managed accounts, or SMAs, add flexibility but at an added cost compared to ETFs, and fees can run as high as 0.65%. And advisory fees should be added to both approaches, using ETFs as well as SMAs, to get an accurate read of total expenses.
Understanding the True Cost of Bond Investing
No small lift when you consider average advisory fees for a $1 million account is over one percent. Fees can be particularly burdensome where fixed income is concerned, because you won't find the next NVIDIA in your bond portfolio.
Fee-Only Advisory vs. ETFs and SMAs
Compared to ETFs or SMAs, hiring a fee-only advisor, one charging reasonable fees, to manage an account of individual bonds may save you a bundle.
Speaker Introduction and Experience
If I haven't met you yet, I'm Ed Mahaffy. I've been helping clients retire for 30 years. My team and I have a fee-only retirement planning firm, and for years I managed fixed-income portfolios for commercial banks, before focusing solely on retirees and pre-retirees.
Tax-Efficient Bond Placement Strategy
Depending on your tax bracket, a winning strategy might be to hold taxable bonds inside tax-deferred accounts, like IRAs, and hold tax-exempt municipals in taxable accounts.
Comparing After-Tax Returns
The key to determining whether municipals may be a good fit is to compare your after-tax return from taxable bonds to that of tax-exempt municipal bonds. Remember, it's less about how much you make, and more about how much you keep. As always, consult your advisor and tax counsel to see if municipals may be a good fit for you.
Medicare Considerations for Municipal Bonds
It's also important to note that income from tax-exempt municipal bonds earned within two years of enrolling for Medicare may cause certain Medicare premiums or charges.
Final Thoughts and Call to Action
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