Today’s podcast explains why it might be a massive mistake to invest in municipal bonds. The reason why this is such an important topic is our unusual fixation with municipal bonds when trying to set up a tax-free retirement.
Interest from municipal bonds counts as provisional income. That means that it counts against the thresholds that cause Social Security taxation. So, while you may be looking for a stable, predictable, tax-free income stream, you could unwittingly lose a portion of your Social Security along the way.
Municipal bonds are usually very attractive for retirees and would-be retirees because they promise low-risk and tax-free income. However, David has noticed five glaring issues about municipal bonds and explains why you should be extremely cautious about investing in them.
Municipal bonds are not always entirely tax-free. Yes, they are free from federal tax, but they are often taxed at the state level if it’s not a bond issued by your resident state. Currently, 43 of the 50 states charge state tax on out-of-state municipal bond interest. So, as state taxes rise over time, you could, unfortunately, fall prey to tax rate risk.
According to David, the whole point of a tax-free municipal bond is to get a superior rate of return when compared to a corporate bond equivalent. The problem is, even though municipal bonds are tax-free, they offer returns that are often far less than their taxable corporate bond equivalents.
One of the biggest problems with municipal bonds is the purchasing power risk. For example, in the high-inflation environment we’re currently in, you’re actually losing spending power by locking into even the most productive municipal bonds. Your returns will lag inflation and massively reduce your spending power over time.
If you’re trying to get consistent, predictable tax-free income in retirement, one of your best bets is owning an annuity inside a Roth IRA. Annuity companies have massive economies of scale and can get rates of return in their bond portfolios that far exceed what you can get on your own.
Mentioned in this episode:
David’s books: Power of Zero, Look Before Your LIRP, The Volatility Shield, Tax-Free Income for Life and The Infinity Code
PowerOfZero.com (free video series)
@mcknightandco on Twitter
@davidcmcknight on Instagram