Municipal
bonds
are
enjoying
a
moment
among
investors
who
are
looking
for
tax-free
income,
but
they
should
be
wary
of
allowing
tax
savings
to
drive
their
decisions.
This
week,
Wells
Fargo
Investment
Institute
highlighted
the
attraction
of
muni
bonds
as
the
Federal
Reserve
prepares
to
trim
rates.
Bond
prices
rise
as
yields
fall,
and
a
falling
rate
environment
would
result
in
price
appreciation
for
municipal
bonds.
“We
remain
favorable
on
municipal
bonds,
both
essential
revenue
and
general
obligation
bonds,
as
they
have
historically
been
resilient
during
periods
of
economic
uncertainty,”
Wells
Fargo
noted
in
a
report
this
week.
“For
investors
in
higher
effective
tax
brackets,
we
believe
municipal
securities
are
an
important
part
of
fixed-income
positioning.”
But
that
is
where
investors
can
make
a
misstep
–
one
that
may
cost
them
valuable
income
opportunities.
Though
municipal
bonds
generally
offer
income
that’s
free
of
federal
income
taxes
–
and
state
taxes
if
the
investor
resides
in
the
issuing
state
–
they
also
come
with
lower
yields
compared
to
other
bonds.
That’s
the
trade-off
investors
make
for
the
safety
of
general
obligation
bonds,
which
are
backed
by
the
full
faith
and
credit
of
the
issuing
municipality.
Even
exchange
traded
funds
holding
municipals
will
have
a
lower
30-day
SEC
yield,
compared
to
their
corporate
counterparts:
The
Vanguard
Tax-Exempt
Bond
ETF
(VTEB)
has
a
30-day
SEC
yield
of
3.64%,
while
the
Vanguard
Total
Corporate
Bond
ETF
(VTC)
has
a
30-day
yield
of
4.17%.
“Munis
aren’t
always
the
best
option,”
said
Nisha
Patel,
senior
portfolio
manager
at
Parametric
Portfolio
Associates.
“There
are
lower
[tax]
brackets,
and
the
client
might’ve
been
better
off
on
an
after-tax
basis
if
they
bought
Treasurys
and
corporates.”
Indeed,
earlier
this
year
Parametric
kicked
off
a
service
it
offers
to
financial
advisors,
building
tax-optimized
bond
ladders
that
are
based
on
an
investor’s
specific
bracket.
Knowing
your
bracket
The
general
rule
of
thumb
is
that
if
your
marginal
tax
rate
is
in
the
24%
bracket
and
above,
you’re
a
better
candidate
for
a
municipal
bond.
When
it
comes
to
muni
bonds,
the
higher
your
tax
bracket,
the
more
valuable
the
tax-free
income
is.
Consider
that
if
a
taxpayer
in
the
32%
federal
income
tax
bracket
picks
up
a
muni
bond
with
a
tax-free
yield
of
3%,
she
would
need
to
find
a
taxable
bond
yielding
4.41%
to
generate
a
comparable
level
of
income,
according
to
New
York
Life
Investments
.
That’s
called
the
tax-equivalent
yield
.
Investors
in
lower
tax
brackets
just
might
pick
up
more
after-tax
yield
in
the
corporate
space,
considering
that
even
though
the
interest
from
corporate
bonds
is
taxed
at
the
same
rate
as
ordinary
income,
the
levy
may
not
take
as
big
of
a
bite
out
of
their
returns.
“The
idea
of
not
having
to
pay
taxes
sometimes
blinds
investors
to
the
idea
that
you
can
still
end
up
with
more
money
if
you
invest
elsewhere
and
pay
taxes
on
that,”
said
Collin
Martin,
fixed
income
strategist
for
the
Schwab
Center
for
Financial
Research.
“You
may
be
able
to
get
a
higher
after-tax
yield
with
something
like
a
corporate
bond,”
he
added.
Treasurys
are
also
another
consideration
for
investors,
as
they
offer
interest
income
that
is
subject
to
federal
tax,
but
exempt
from
state
and
local
taxes.
A
tax-conscious
approach
to
fixed
income
You
don’t
have
to
bulk
up
on
municipal
bonds
to
get
the
best
yield
for
your
tax
scenario.
Here’s
where
to
begin.
Think
about
your
time
horizon
and
your
effective
tax
rate.
You
may
be
in
a
high
tax
bracket
now,
but
whether
it
makes
sense
to
load
up
on
munis
will
depend
on
how
that
situation
may
evolve.
“If
they’re
paying
taxes
at
the
highest
marginal
rate,
but
plan
to
retire
in
three
years
–
at
which
point
they
won’t
have
wages
–
their
marginal
tax
rate
will
drop,”
said
Michael
Carbone,
certified
financial
planner
and
financial
advisor
at
Eppolito
Financial
Strategies
in
Chelmsford,
Massachusetts.
In
that
case,
the
tax-equivalent
yield
on
a
muni
may
have
seemed
promising
in
those
high-earning
years,
but
it
becomes
much
less
attractive
once
earnings
drop
off.
Consider
where
you’re
keeping
these
bonds.
Save
on
taxes
by
ensuring
that
your
bonds
are
in
the
correct
accounts.
Municipal
bonds
are
good
contenders
in
taxable
brokerage
accounts,
where
investors
can
benefit
from
their
tax-free
income.
Corporates
and
the
funds
that
hold
them
–
especially
given
higher
yields
–
might
be
better
suited
for
tax-deferred
accounts,
such
as
your
individual
retirement
account,
given
the
tax
treatment
of
their
interest
income.
Shopping
for
tax-aware
funds?
Do
your
homework.
Some
fund
families
offer
“tax-aware
strategies”
either
in
mutual
funds
or
ETFs,
which
can
include
some
exposure
to
municipal
bonds,
as
well
as
equities.
These
options
may
help
investors
save
on
taxes,
but
they
should
understand
what
these
portfolios
hold
and
how
much
they
cost.
“As
we
spend
more
time
understanding
these
tax-aware
strategies
that
have
popped
up
in
the
last
five
years,
it’s
better
to
understand
what
is
in
the
portfolios
and
where
risks
can
surface,”
said
Beth
Foos,
associate
director
of
fixed
income
strategies
at
Morningstar.
“Looking
at
the
fees
and
understanding
how
they
impact
your
results
is
really
important.”
