Retirement planning amid coronavirus crisis
Barron’s senior writer Reshma Kapadia and Barron’s Roundtable discuss how coronavirus upended some people’s retirement plans and what can be done to make up for that lost capital.
Though you should expect to collect some money from Social Security as a senior, and you may have a decent amount of retirement savings to tap, generating extra income during your later years is never a bad idea. You never know when costly home repairs or medical bills might creep up out of nowhere, and the more income sources you have at your disposal, the less financial stress you'll have.
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That said, having different sources of income could also mean giving the IRS more opportunities to get its hands on your money. Case in point: Social Security benefits are often subject to taxes, as are retirement plan withdrawals that don't come from a Roth savings account. Interest income in your bank account is taxable, and pension payments are generally subject to taxes, too.
But what if you could boost your retirement income without adding to your tax burden? There actually is a solution that will let you do just that: municipal bonds.
Why municipal bonds really pay
During retirement, it's a good idea to focus on investments that aren't particularly risky or volatile, and in that regard, municipal bonds fit the bill. Municipal bonds are those issued by cities, states, or other localities (whereas corporate bonds are issued by companies to raise capital). A city might issue municipal bonds to construct a new road, revamp its parks, or build a community center.
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As is the case with all bonds, when you buy municipal bonds, you're effectively loaning the issuer some money for a present period of time in exchange for interest payments that are made to you twice a year. Once your bonds come due, you're entitled to your principal in return. It's those interest payments, however, that generally trigger an extra tax bill, but with municipal bonds, they be avoidable completely.
The interest you collect on municipal bonds is always tax-exempt at the federal level. Furthermore, if you buy municipal bonds issued by your state of residence, you'll avoid state and local taxes on those interest payments as well. Or, to put it another way, if you invest in municipal bonds that pay you $500 a year in interest, that $500 will be yours to keep in full.
Now to be clear, the tax-exempt status of municipal bonds refers to their interest payments alone. If you sell your municipal bonds at a profit, you'll still be subject to capital gains taxes, the same way you would if you were to sell off some stock at a share price that's higher than what you paid. But collecting those steady interest payments tax-free could make for a much more comfortable retirement, and so it's worth adding some municipal bonds to your portfolio.
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Keep the IRS away
Taxes are a burden at any age, but they can be especially troubling during retirement, when your income may be limited. Municipal bonds will take that particular worry off of the table so you can sit back, collect your interest twice a year, and not have to think about the IRS until the time comes to file your annual return.
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