Here's a statement of the obvious: The opinions expressed here are those of the participants, not those of the Mutual Fund Observer. We cannot vouch for the accuracy or appropriateness of any of it, though we do encourage civility and good humor.
I am relatively new to investing in Municipal bonds, but thanks to MFO have a powerful tool for researching funds. Fidelity has a search tool that allows you to search individual Muni bonds by state and category (Education, Revenue, etc). I retired in Colorado and invested in the only Colorado Muni fund that I have run across, WTCOX, for diversity. @Baseball_Fan pointed out the benefits of investing in infrastructure (schools, sewers, hospitals), and I did have a good feeling about investing in my new home state.
"Environmental, social, and governance (ESG)" investing is a good concept, in my opinion, but the controversy comes in how to measure it in order to allocate to specific funds. It is not a subject that I have followed closely. My former employer spent a lot of money on ESG practices, and part of my job included reclamation, environmental protection, and preparing for climate change, among others. Some companies are more ESG conscious than others.
@msf points out that not all Muni bonds invest in projects that will stand the test of time such as dams and infrastructure doesn't imply ESG. I recently read an article that some organization (Army Corp of Engineers?) is tearing down hundreds (thousands?) of dams and returning the streams to the original conditions. Sure, Muni bonds have invested in projects that used lead pipes for water or asbestos for insulation. Overall Muni bonds have been instrumental in helping with growth. We learn over time.
Thanks for the links on Lebenthal and green bonds, @msf. I will watch it later today.
The green bonds piece is solid, and the 10 minutes to watch it are well spent.
The Lebenthal ads are mostly for amusement, though he did a good job of getting across the point that munis support infrastructure. Unfortunately, I had a hard time finding a complete ad - what I posted was a compendium of clips.
I finally found a complete ad, albeit one he made toward the end of his career.
And a 4 minute interview with him at CNN about the ads and about munis.
Fidelity has a search tool that allows you to search individual Muni bonds by state and category
Be aware that market discount (the difference between the "correct", often par price and the market price) is generally treated as ordinary, taxable income upon redemption or sale of a bond. The exception is if it satisfies a de minimis rule, in which case the gain is still taxable, but as a capital gain.
So when looking at individual issues, it's important to keep in mind that the "tax equivalent yield" is not as high as you might think. Part of the YTW could be taxable.
Market discount hasn't been a concern until recently, after we emerged from ZIRP and after interest rates rose more than a couple of percent. Before then, virtually all secondary market munis (that had been issued in older, higher rate times) were being sold at premiums.
Logic says that this feature of muni bonds - that gain due to market discount is taxable - should apply to muni bond funds also. It's hard to find anything on this. I did dig up a Pimco footnote that seems to confirm this thinking:
Pragmatically this may be a non-issue. Mutual funds pay expenses (management fees, other expenses). Those expenses reduce net taxable income. Since muni bond funds shouldn't be generating much taxable income, the funds should have none left after accounting for expenses.
To be clear, the WSJ piece is not about the shopworn lament that retail bond investors, and more specifically retail muni bond investors, pay high transaction costs.
Rather, it is referencing an NBER working paper that concluded that retail muni bonds investors in the highest federal and state tax brackets were losing 15 basis points in return (on average) relative to what they could get after-tax on taxable bonds of comparable quality. Which of course means that the rest of us are losing even more.
The paper's authors hypothesized that the greater a taxpayer's propensity to avoid paying taxes (e.g. moving to lower tax states) the more they are likely to overpay (accept lower returns) from munis. Which seems sort of obvious, akin to cutting off one's nose to spite one's face.
Schwab (July 25, 2023) has a different take, viz. that if you're in a 45% or higher combined bracket (e.g. 37% federal + 3.8% Medicare + 10.75% state = 51.55%), you are likely to come out better with munis. But this breakeven percentage varies over time and has averaged 32% since 2010. https://www.schwab.com/learn/story/municipal-vs-corporate-bonds-how-to-choose
That's a great article, @msf. Thanks. I agree with the Schwab article. In addition, there is the Medicare income adjusted premium (IRMAA) which can add another penalty of around 3% for increasing Modified Adjusted Income (MAGI) from $245,000 to $366,000. Tax-exempt income is not included in AGI, but is included in MAGI.
Below are the Married Filing Jointly thresholds for Federal Tax based on Adjusted Gross Income and Income Adjusted Premium (IRMAA Parts A & B) based on the Modified Adjusted Gross Income which includes tax exempt income. The Net Investment Income Tax (3.8%) starts at $250,000. The big jump in the Federal Income Tax jumps from 24% to 32% at $364,200. IRMAA increases by $2,837 when one crosses the $246,000 MAGI Threshold, another $2,837 when one crosses the $306,000 MAGI Threshold, and another $2,837 when one crosses the $366,000 MAGI Threshold.
I am overweight in Traditional IRAs and have deferred Social Security Benefits in order to keep income low for a Roth Conversion and collect a higher Social Security Benefit later. Higher Roth Conversions now reduce RMDs and income taxes later. Depending upon one's goals and savings to pay taxes on a Roth Conversion, there are benefits for Roth Conversions to target AGI/MAGI between the $245,000 to $365,000 range in rough numbers.
I have modeled my preferred plan in a spreadsheet for the next ten years and reviewed it with my CPA. This will become an annual process because there are so many assumptions. For me, it's a trade-off to pay higher taxes now with a Roth Conversion and paying lower taxes with Municipal Bonds. Leaving a tax-efficient inheritance is another factor.
I moved from a state with no income tax to a state with income tax for better "quality of life".
Comments
"Environmental, social, and governance (ESG)" investing is a good concept, in my opinion, but the controversy comes in how to measure it in order to allocate to specific funds. It is not a subject that I have followed closely. My former employer spent a lot of money on ESG practices, and part of my job included reclamation, environmental protection, and preparing for climate change, among others. Some companies are more ESG conscious than others.
@msf points out that not all Muni bonds invest in projects that will stand the test of time such as dams and infrastructure doesn't imply ESG. I recently read an article that some organization (Army Corp of Engineers?) is tearing down hundreds (thousands?) of dams and returning the streams to the original conditions. Sure, Muni bonds have invested in projects that used lead pipes for water or asbestos for insulation. Overall Muni bonds have been instrumental in helping with growth. We learn over time.
Thanks for the links on Lebenthal and green bonds, @msf. I will watch it later today.
The Lebenthal ads are mostly for amusement, though he did a good job of getting across the point that munis support infrastructure. Unfortunately, I had a hard time finding a complete ad - what I posted was a compendium of clips.
I finally found a complete ad, albeit one he made toward the end of his career.
And a 4 minute interview with him at CNN about the ads and about munis.
https://www.msrb.org/Making-Impact-ESG-Investing-and-Municipal-Bonds
Be aware that market discount (the difference between the "correct", often par price and the market price) is generally treated as ordinary, taxable income upon redemption or sale of a bond. The exception is if it satisfies a de minimis rule, in which case the gain is still taxable, but as a capital gain.
https://www.schwab.com/learn/story/beware-taxes-on-discounted-munis
https://www.msrb.org/sites/default/files/Tax-and-Liquidity-Considerations-for-Buying-Discount-Bonds.pdf
So when looking at individual issues, it's important to keep in mind that the "tax equivalent yield" is not as high as you might think. Part of the YTW could be taxable.
Market discount hasn't been a concern until recently, after we emerged from ZIRP and after interest rates rose more than a couple of percent. Before then, virtually all secondary market munis (that had been issued in older, higher rate times) were being sold at premiums.
Logic says that this feature of muni bonds - that gain due to market discount is taxable - should apply to muni bond funds also. It's hard to find anything on this. I did dig up a Pimco footnote that seems to confirm this thinking:
"institutional investors, such as mutual funds, generally amortize market discount into current income as taxable income."
https://www.pimco.com/en-us/resources/education/understanding-the-de-minimis-tax-rule/
Pragmatically this may be a non-issue. Mutual funds pay expenses (management fees, other expenses). Those expenses reduce net taxable income. Since muni bond funds shouldn't be generating much taxable income, the funds should have none left after accounting for expenses.
The Hidden Costs of Retail Purchases in Municipal Bonds, S&P Global, June 2022.
Rather, it is referencing an NBER working paper that concluded that retail muni bonds investors in the highest federal and state tax brackets were losing 15 basis points in return (on average) relative to what they could get after-tax on taxable bonds of comparable quality. Which of course means that the rest of us are losing even more.
The paper's authors hypothesized that the greater a taxpayer's propensity to avoid paying taxes (e.g. moving to lower tax states) the more they are likely to overpay (accept lower returns) from munis. Which seems sort of obvious, akin to cutting off one's nose to spite one's face.
Not much more in the WSJ piece (URL worked for me w/o logging in):
https://www.wsj.com/finance/investing/municipal-bonds-tax-free-price-74d4bbcf
NBER working paper:
https://anderson-review.ucla.edu/wp-content/uploads/2023/07/MuniPremiumLongstaff.pdf
Schwab (July 25, 2023) has a different take, viz. that if you're in a 45% or higher combined bracket (e.g. 37% federal + 3.8% Medicare + 10.75% state = 51.55%), you are likely to come out better with munis. But this breakeven percentage varies over time and has averaged 32% since 2010.
https://www.schwab.com/learn/story/municipal-vs-corporate-bonds-how-to-choose
Below are the Married Filing Jointly thresholds for Federal Tax based on Adjusted Gross Income and Income Adjusted Premium (IRMAA Parts A & B) based on the Modified Adjusted Gross Income which includes tax exempt income. The Net Investment Income Tax (3.8%) starts at $250,000. The big jump in the Federal Income Tax jumps from 24% to 32% at $364,200. IRMAA increases by $2,837 when one crosses the $246,000 MAGI Threshold, another $2,837 when one crosses the $306,000 MAGI Threshold, and another $2,837 when one crosses the $366,000 MAGI Threshold.
Basis AGI MAGI
Threshold Fed Tax Medicare NIIT
Married Premium
(Jointly) (Couple)
$22,000 12% $3,958
$89,450 22% $3,958
$190,750 24% $3,958
$194,000 24% $5,832
$246,000 24% $8,669
$250,000 24% $8,669 3.8%
$306,000 24% $11,503 3.8%
$364,200 32% $11,503 3.8%
$366,000 32% $14,340 3.8%
$462,500 35% $14,340 3.8%
$693,750 37% $14,340 3.8%
$750,000 37% $15,286 3.8%
I am overweight in Traditional IRAs and have deferred Social Security Benefits in order to keep income low for a Roth Conversion and collect a higher Social Security Benefit later. Higher Roth Conversions now reduce RMDs and income taxes later. Depending upon one's goals and savings to pay taxes on a Roth Conversion, there are benefits for Roth Conversions to target AGI/MAGI between the $245,000 to $365,000 range in rough numbers.
I have modeled my preferred plan in a spreadsheet for the next ten years and reviewed it with my CPA. This will become an annual process because there are so many assumptions. For me, it's a trade-off to pay higher taxes now with a Roth Conversion and paying lower taxes with Municipal Bonds. Leaving a tax-efficient inheritance is another factor.
I moved from a state with no income tax to a state with income tax for better "quality of life".