SOCIAL SECURITY AND MUNI BONDS
We frequently discuss the media's many misperceptions about municipal
bonds. Whether on high profile, national financial television shows
or in local newspaper columns, many in the media seek to unravel
what they consider the mystery behind muni bonds.
However, the real mystery isn't in the investments themselves,
but in the analyses by these so-called experts. While it would be
fruitless to address every false assertion, it is worthwhile to
point out some glaring errors lest they ultimately become accepted
wisdom.
In a recent example, brought to our attention by astute investor
S.D., from Connecticut, the magazine "NARFE" (National
Active and Retired Federal Employees Association) published an article
that took aim at munis as a poor choice for investors receiving
Social Security benefits. Mixing the two, he said, is like trying
to combine oil and water. However, a further analysis reveals that
it may be the chef - not the ingredients - that is spoiling the
mix.
Incredibly, the author advises "reducing or eliminating tax-free
bonds from your investment portfolio if you are collecting Social
Security". The problem with mixing munis and Social Security
benefits, the author says, is the "provisional income"
gained through muni bonds. Investors would be better off, he says,
considering CDs, U.S. Treasuries or corporate bonds.
We are surprised the author is unaware that interest earned from
these instruments is also considered "provisional income".
All taxable interest must be included in your adjusted gross income.
Curiously, the author mentioned that provisional income includes
adjusted gross income, so why would CDs, U.S. Treasuries, or corporate
bonds be preferable to municipal bonds? Since these are taxable
investments they will likely pay a higher rate of interest than
municipals and when added to the adjusted gross will actually produce
more provisional income than tax-free bonds. Clearly, this is not
the objective.
In a further effort to make his case, the author asserts that interest
earned from munis could also be subject to the Alternative Minimum
Tax.
Indeed it could, yet there are literally thousands of municipal
bond issues that are not subject to the AMT. The author also neglects
to mention that if the investor is an AMT taxpayer, his/her income
from taxable investments will also be subject to the AMT, which
makes AMT irrelevant in this discussion.
Demonstrating a tremendous command of the obvious, the author declares
that muni bonds are not FDIC insured. Right again, but that's like
saying the commissioner of baseball doesn't govern the NFL. The
FDIC doesn't insure munis. Bond insurers do, and as most investors
know, there are many insurers, such as MBIA, AMBAC, and FGIC to
name just a few.
Finally, the author says that municipal bonds are subject to price
fluctuations.
Right again - but what investment is free from risk? If you have
ever tried redeeming an insured bank CD before maturity, you know
about the punitive fees and penalties. Treasuries and corporate
bond prices will also fluctuate. All however, can be redeemed at
face value if held to maturity.
What's lost in this and many other analyses is the simple objective
of municipal bonds: a safe, steady stream of tax-free income. Investors
recognize this advantage, regardless of whether they collect Social
Security benefits.
Perhaps it's the simplicity that drives many of these "experts"
to distraction.
05/02/06
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