Municipal bonds are seen by the ultra-wealthy as more than just an interest-earning venture. They can secure tax-free income, cover basic expenses, and enable other portions of their portfolio to pursue more aggressive investments. However, municipal bonds do not fit every retiree's need and carry overlooked risks.
A major attraction of municipal bonds to wealth retirees is the aspect of taxes. As Noah Damsky, founder of Marina Wealth Advisors mentioned, "Municipal bonds can offer stable, top-notch, tax-exempt income". Although they are federal tax-free, they are sporadically state tax-free. If the bonds are issued from the investor's state of residence, they may also be exempt from state and local taxes. This tax reduction for those in higher brackets can serve as a formidable way to safeguard wealth while averting excess tax payments.
Despite being perceived as highly safe, municipal bonds are not without their drawbacks. Damsky warns that these bonds "are not devoid of risks" and can carry considerable interest rate risk along with some credit risk. Moreover, liquidity is another factor that can be overlooked, with municipal bonds often being challenging to trade at favourable prices in larger volumes, particularly in a strained market.
Unexpected tax bills can also arise from purchasing the wrong type of municipal bond; not all retirees are equipped for this surprise. For instance, if one buys a private activity bond and the income is substantial, the interest could be liable to the Alternative Minimum Tax (AMT).
For retirement planning, it is crucial to understand municipal bonds and their potential drawbacks. For the ultra-wealthy, they serve as part of a broader strategy for creating a growth and income portfolio that relies on other assets as well. Once these individuals are confident about securing their lifestyle with conservative investments, they reach out to high-growth investments to build generational wealth.
But as Damsky points out, "Municipal bonds are great for maintaining existing wealth, but they are unlikely to compound wealth over the long term". Therefore, investors aiming for aggressive wealth building in retirement might need to redirect from relying heavily on municipal bonds.
Municipal bonds can be an impressive investment instrument, but, like any tool, they are only beneficial when they serve the purpose of attainment. The ultra-wealthy adopt municipal bonds to establish a reliable basis of predominantly tax-free income while making other bold investments, but these bonds are neither risk-free nor a one-size-fits-all investment solution. Understanding the workings and potential complications of municipal bonds can guide you in crafting a retirement plan suitable for your objectives.