A retirement plan should include reliable income sources — Social Security, 401(k), IRA distributions, etc.—as well as lower-risk investments.
The best approach is both to mix and hedge. The mix should include the reliable income sources. About 40% of that mix is your Social Security income. Plan ahead and choose the best time to begin starting that lifetime benefit. The longer you wait, the bigger the monthly check will be.
The remaining 60% is a combination of hedging your bets and leveraging tax advantages to finance the living expenses for your retirement years. You cover those expenses, in part, with retirement savings that grow over time. The earlier you start that planning, the more money you’ll have to live on. Don’t be in that group of workers who are waiting too long to begin retirement savings plans.
Consider also low-risk and tax-exempt retirement investments that round out a portfolio. The operative term is “low-risk.” One investment that meets that criterion is municipal bonds.
Municipal bonds usually yield lower interest rates than corporate bonds. However, like US treasury bonds, any interest earned is tax free. Be aware however, that the tax-exempt status applies only to the interest payments. Selling a bond for more than its original price, however, makes the sale subject to capital gains taxes.
A municipal bond is how a state or municipality raises money to fund public works. It is a public offering for a debt where investors lend money to the government entity for an agreed period of time.
The issuer, in turn, promises to pay the bond purchaser (i.e., the investor) a set amount of interest over the lifetime of the bond. Interest payments are typically twice a year, and when the bond period expires, the investor reclaims the principal. Municipal bond values are usually more stable than stocks. Their value is easy to calculate. Just add up the bond’s face value and the interest it pays.
There are two types of municipal bonds: revenue bonds and general obligation bonds.
1. Revenue Bonds: These bonds finance public projects designed to generate revenue for the municipality. Those projects would include toll roads or a concert hall. Whatever cash the project earns is used to pay back investors.
It is important to note that revenue bonds have a higher default rate than general obligation bonds (see below). The project could be completed late, exceed budget costs, and fail to generate projected revenues. Investors need to check the issuer’s credit rating before risking capital.
2. General Obligation Bonds: These fund public projects. Building city parks or improving a school system don’t generate revenue, but they improve the community. General obligation bonds are safer investments and are secured by the full faith and credit of the issuer.
Investors can buy municipal bonds through new issues, on the secondary bond market, or through bond funds. Whatever type of the bond purchase, there is always a broker involved. Shop around to get the best deals on brokerage fees as well as to learn what markups are involved when you sell the bond.
