2 Reasons to Love Tax-Free* Muni’s
As if the tax-free income isn’t enough of a reason, here are 2 more reasons that Tax-Free municipal bonds may become even more attractive in the future.
1. Tax rates are going up [probably]
Tax-free muni bonds have always been an attractive investment for their combination of high quality, low default rates, and Taxable Equivalent Yields (TEY). The TEY represents the amount of yield you need before taxes to realize the equivalent income of a tax-free. The TEY goes up as your tax bracket increases making tax free income more powerful if you are in a high tax bracket. The greater your tax bracket is, the more interest you keep when compared to a taxable investment.
Therefore if tax rates go up, after tax yields shown above will be going down on taxable investments and the TEY’s will be going up on tax-frees.
2. Supply of Tax Free bonds is going down. Permanently.
The government needs income, desperately. With the economy hurting, tax receipts are down- and this has many municipalities scrambling for revenues. The new generation of municipal bonds is called Build America Bonds (BAB), and these bonds are taxable. Interest rates will be higher, and while interest is taxable to investors, BAB’s are attractive to municipalities because of a federal subsidy payment direct to the municipality equal to 35% of the total interest owed to investors.
Tax-free bonds will still be in demand by those in the highest tax brackets. With supply going down, and demand for tax-free income remaining strong…tax free bonds should command a premium, especially to investors in a high tax bracket.
Remember: It’s not what you earn, it’s what you keep.
*Municipal bonds are federally tax free but may be subject to state and local taxes, and interest income may be subject to the alternative minimum tax. The purchase of bonds is subject to availability and market conditions. Generally, the bond market is volatile, bond prices rise when interest rates fall and vice versa. Market risk is a consideration if sold or redeemed prior to maturity. Some bonds have call features that may affect income. Stocks also tend to be most volatile, while bonds offer a fixed rate of return. In general, the higher the risk, the higher the potential return.
