Municipal bonds have been an allocation for high income earners for quite a long time. In recent years, many municipalities have been able to refinance their issued debt with taxable debt with lower rates which has made municipal bonds less attractive, just as many have done with their mortgages. However, municipal bonds have been an area I have kept my eye on for two major reasons: the rise of interest rates and the sunset of provisions in the Tax Cuts and Jobs act of 2017.

Interest Rates

In the most recent news, the November 2023 CPI report concluded that inflation has been cooling. With this news, the S&P 500 has been increasing as the Federal Reserve made a statement about stopping any more rate hikes and targeting three rate cuts in 2024. The reason why this is important is there is an inverse relationship between interest rates and fixed income securities (bonds).

For example, if I buy a 5-year AAA rated bond of ABC Company with a 5% yield and interest rates increase to 6%, then investors would opt to purchase the newer investment with the higher interest rate and same term. Let’s say for this example, that XYZ Company just recently issued 5-year AAA rated bond yielding 6% as they needed money to fund expansion. For investors who hold onto the ABC Company bond, their investment is likely trading at a discount to what they purchased it for. They will still get the same interest rate on their investment and the return of capital once the bond matures. However, you must recognize that you could have gotten a higher return by selling the ABC Company bond and purchasing the XYZ, which is the opportunity cost of holding the 5% instrument.

Another piece of information I would like to touch on is how the term of the bond is also impacted by interest rates. The longer the term of the bond, the more the bond is impacted by changes in interest rates. For example, let’s say I bought a 30 year bond yielding 4% two years ago when interest rates were very low because I needed cash flow. That same bond is not as valuable today as I can get above a 4% yield in my savings account. Everyone asks, why on earth would you do that? The answer is simple, sometimes people (especially retirees) need income and have to invest in securities that are going to hit their income needs.

I am now going to switch gears to municipal bonds. There are two main types of municipal bonds, General Obligation (GO) and Revenue Bonds. A GO bond, for example, might be Mecklenburg County North Carolina issuing a bond to help pay for a new public school. The reason why it is called a General Obligation municipal bond is because it is backed by the full faith and credit of the issuer which in this case is Mecklenburg County. The other type of municipal bond is called a Revenue Bond. A revenue bond is a bond that is supported by the revenue of the project such as a utility or toll road.

The reason why the high-income earners like municipal bonds as part of their portfolio is due to the tax-free nature of their income. Due to what is called Intergovernmental Immunity, the Federal Government cannot tax state issued debt and the states cannot tax Federal debt. Additionally, most states allow you to take a deduction on your state tax return for the interest paid to you by their state’s municipal bonds. With this combination of interest being federal and most likely state tax exempt, makes municipal bonds a good allocation for high income earners in high tax states.

Please review the example below to show what investing in a Savings Account vs a Municipal Bond might look like:

As you can see above, the net income after tax is higher for the municipal bond. This doesn’t come without some risks though. The XY Savings Account is flexible and can be accessed very quickly, while the municipal bond will need to be sold. Additionally, you need to make sure you are comfortable with the risk profile of the municipality because if it goes bankrupt, you may not get much or any of your investment back. I would also caution you to make sure you diversify your holdings rather than having all of your investment in one municipality. This is why state specific mutual funds, exchange traded funds, and separately managed accounts are useful to diversify without having to make a large investment.

The 2025 Sunset of Provisions in the Tax Cuts and Jobs act of 2017

At the end of 2017, President Trump enacted the new provisions to the tax code which included lowering the top federal bracket from 39.6% to 37% (including new tax brackets) as well as a slew of other provisions such as the qualified business income deduction for business owners and the increases in estate and gift tax exemption.

It is my firm belief, that taxes will be going up when these provisions sunset. In addition to well known strategies such as Traditional to Roth IRA conversions at these lower tax brackets and harvesting capital gains, I would also consider municipal bonds as a great place to be when this occurs. I believe the value currently held municipal bonds will rapidly increase with a substantial change to the United States tax landscape.

This is just one of my convictions based on my research and the current market environment. Feel free to reach out to me to further discuss your financial situation and if municipal bonds may be a good fit for your portfolio.







The information provided is for educational and informational purposes only and does not constitute investment advice and it should not be relied on as such. It should not be considered a solicitation to buy or an offer to sell a security. It does not take into account any investor’s particular investment objectives, strategies, tax status or investment horizon. You should consult your attorney or tax advisor.

The views expressed in this commentary are subject to change based on market and other conditions. These documents may contain certain statements that may be deemed forward looking statements. Please note that any such statements are not guarantees of any future performance and actual results or developments may differ materially from those projected. Any projections, market outlooks, or estimates are based upon certain assumptions and should not be construed as indicative of actual events that will occur.

All information has been obtained from sources believed to be reliable, but its accuracy is not guaranteed. There is no representation or warranty as to the current accuracy, reliability or completeness of, nor liability for, decisions based on such information and it should not be relied on as such.

This information is general in nature and should not be considered tax advice. Investors should consult with a qualified tax consultant as to their particular situation.

Diversification does not ensure a profit or guarantee against loss.

Although bonds generally present less short-term risk and volatility risk than stocks, bonds contain interest rate risks; the risk of issuer default; issuer credit risk; liquidity risk; and inflation risk.