As I am closing in on my retirement, I am looking at one specific option that seems to make easy sense to me, and I was wondering if I were missing something.I will use round numbers to make this easy. If I have $1 million and invest in a series of long term muni bonds from various counties/project in the state I am living, I can earn approx $55 to $60 tax free, plenty for me to live on.I understand the risk that the municipality may either go bankrupt or stop paying dividends or call the bonds, but it seems straight forward.Am I missing something?
As I see it, you are not accounting for inflation risk. What will 55-60k be worth 25 or 30 years from now? And will it still be enough for your needs? Not an unrealistic expectation for many of us.I have a significant portion of my retirement portfolio in equities to allow for growth. Last year taught me maybe too much. Still with a 25-30 year horizon, I think I continue to need exposure to growth.LdF
You are missing something. With $1M in any type of fixed income portfolio, you'll have to take a certain (large) percentage of your yield and re-invest in more municipal bonds in order to keep up with inflation.If your $1M yields a nominal 6% per year or $60K and prices for goods and services are increasing by 4% per year, you'll have to take $40K or 2/3rds of that pre-tax $60K and buy more municipal bonds.That will leave you with $20K to pay the taxes on that $60K of income. You get to live on the rest for the rest of the year. That's an annual withdrawal rate of less than 2% --- probably around 1% after taxes.
If I have $1 million and invest in a series of long term muni bonds from various counties/project in the state I am living, I can earn approx $55 to $60 tax free, plenty for me to live on.I understand the risk that the municipality may either go bankrupt or stop paying dividends or call the bonds, but it seems straight forward.Am I missing something? Actually, you're missing more than "something". You're missing a lot.1) Default risk. Depends maybe on where you live, but look at what's happening in California. IIRC New York a few years back declaired a "financial emergency" and ceased paying the dividends.2) Inflation. Look backwards for 20 years--or however many years you think you'll live after you retire. I just retired after 30 years with my company. My initial salary was an extremely generous $16,000 per year. Thirty years later, that amount would barely cover my car & health insurance premiums. $60k today is a quite a bit. In 20-30 years, $60K probably won't even cover your grocery bill.3) Unless you are a multi-millionare, tax-free bonds are stupid. You give up significant yield in exchange for the lower taxes.
My plan is to purchase tax free bonds, so taxes should not be an issue. As to inflation, I see it a couple of ways, I dont see inflation as a constant 4% for all goods and services. If for example, housing increases by 9%, it may not effect me. Obviously health care increasing by 10% would effect me more than something like travel or hotels.My other factor is social security. Assuming I will benefit from it in the next 15 years, it would be additional income. Also, I am not looking to leave my children with $1million, so principal reductions over time is certainly another probability.
Which municipal bonds are US federal income tax free? Many of us would be very interested in these types of bonds <grin>!
Which municipal bonds are US federal income tax free? Virtually all of them.--Peter
At this point in time, municipal bonds seem to me to be particularly risky.Many cities and states are having problems making their budgets. In addition, many have huge pension obligations, which may or may not be funded properly.It might even be a popular decision to default on some bonds rather than to default on pensions.I think that you would have to do a lot of research before being able to make a good decision, and we all know that the rating agencies are useless.If a city or state gets into trouble, the bonds will decrease in value, and you will have to make the decision to take the loss or to risk default. Not an easy decision.
I am not looking to leave my children with $1million, That's fine.How long are you going to live?Are you planning to keel over after 10 years? Then inflation maybe isn't too big a concern.But what if you are like the guy I saw in the doctor's office yesterday. Next week is his 100th birthday. As he told all the nurses several times. In a loud voice.You'd better believe that inflation is a big concern if your timeframe is 35 years.Myself, I don't have any desire to have to get a job as a Walmart greeter at age 80.
Me: Which municipal bonds are US federal income tax free? Peter: Virtually all of them.Me dumb-dumb <grin>! I always thought that munis were local and state income tax free. I had it backwards.Then again, I've never been interested in munis. I'm not rich enough.
Me dumb-dumb <grin>! I will refrain from comment. ;-)I always thought that munis were local and state income tax free. I had it backwards.Generally, in-state munis are also free of state income taxes. So you had it right as far as you went, but you didn't have it fully right.It's US Treasury securities that are taxable on the Federal level, but free of state income taxes.--Peter
Peter, thank you for clearing it up. When one risk rates muni bonds to other kinds of investments, muni bonds are significantly safer than other vehicles. Even in states like CA where the state constitution require that the state honor general obligation bonds before all else except for education. Additionally, the bonds that hold the highest risk are revenue bonds, having a diversified portfolio of state and muni bonds reduces that vulnerability.I appreciate the inflation component, but living within ones own means even in retirement is doable.
I agree. A significant portion of my retirement funds is in municipal bonds, mostly issued by my state, but some issued by Puerto Rico. Puerto Rican munis are free of federal tax in all states. Some revenue bonds are subject to AMT, the Alternative Minimum Tax. This information is provided on the web site if you buy your bond through e-Trade and probably other discount brokers as well. If you are using a full service broker (not that much more expensive, for bonds) you should be told whether the bond is subject to AMT. Depending on your other income, this may or may not be an issue. If it is not an issue for you, bonds subject to AMT usually pay a little more than those that are not. You can arrange your munis so that you get a check every month, or twice a month. You know most municipals pay twice a year. Construct a ladder so you have something maturing every year, planning to reinvest that principal in a new bond. I think it is also important to have a portion of retirement funds in stocks that will grow, but muni bonds are great for income. Best wishes, Chris
Chris,I have looked at both AMT and laddering of payments. I am not sure if I want to have bonds maturing every year though. There is a part of me that likes having the vast majority of bonds mature in 15-20 years and living off the interest and only selling a bond if I need a bit more that year.As far as a stock portfolio, I am looking to invest in an index mutual fund, possible the Fool Fund that I am just reading about.
The idea of the ladder is not to buy everything when interest payments are lowest. If you have a 5-year ladder, then when a bond matures, you take the money and buy another five years out, achieving exactly the goal you wish. An exception is when 15-20 year bonds are paying much higher interest than 5 year bonds, and you are SURE the rates will not go higher and want to lock in that yield for that long a time. Best wishe, Chris
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