Monday, Sep. 27, 2010

Municipal Bonds: Because Taxes Are Headed Higher

The only sure things in life, death and taxes, are now both under revision. People are living longer, and taxes are set to go higher. Don't waste time trying to divine the intentions of Congress. "We just tell our clients to assume that tax rates of all kinds will be drifting up in the years ahead," says Kevin Grimes, whose eponymous financial advisory is based in Westborough, Mass. But even that certainty does not make muni bonds a no-brainer. Many cities and states are in dire financial shape over outsize pension obligations and the loss of tax revenue due to the sluggish economy. "The message I give people is, Diversify, diversify," says John Ameriks, who heads Vanguard's investment-counseling and research arm. That means not plunking all your eggs in your own state's munis even if such concentration maximizes your state-tax savings. Finally, says Grimes, don't bother with munis today unless after all deductions you still find yourself with a high tax rate. "The yields on munis are now just too low for them to make sense for people in lower tax brackets," he says. In late September, according to Bloomberg data, the current yield on 10-year munis averaged 2.55%, which translates to a taxable-equivalent yield of 3.45% for someone in the 28% tax bracket. A higher tax rate would make that payoff even better.