Municipal Bonds vs. Treasury Bonds: Which to Choose?
Municipal bonds and Treasury bonds are both valuable components of a diversified portfolio. These are either issued by the Treasury Department or municipalities - state and local governments. But each of these securities is taxed differently, so how can you choose which one to invest in for your taxable account?
Taxability of Treasury Bonds
If you own a non-IRA account, such as a brokerage account or an individually registered account, those yearly dividends, interest, and capital gains will be taxed as income on a 1099 form. For Treasury bonds, interest is paid out depending on the maturity level of the bond. Typically, longer-term bonds produce a higher yield than short-term bonds. However, because of inflation and recession fears, the yield is inverted: short-term yields are higher than long-term right now.
Treasury bonds are typically taxed at the federal level, but not the state level, which equates to a tax benefit.
Taxability of Municipal Bonds
Municipal bonds help state and local governments fund projects such as school systems, waterways, airports, and other infrastructure projects. Typically, the interest from municipal bonds are tax-free at the federal level; in certain states like California and New York, they are also not subject to state income tax if an investor holds muni bonds issued by the state they reside in. This is beneficial if you’re in a higher tax bracket because you may receive a higher yield.
For example, if you’re in the 37% marginal federal tax bracket, you are also subject to a 3.8% surcharge tax on net investment income at the federal level. The yield on a long-term Treasury bond is about 3.8-4% (as of November 2022). The yield on a long-term municipal bond after-tax, meanwhile, is closer to 5% or 6% due to its federal tax-free status.
Are municipal bonds right for everyone?
With recession fears and inflation affecting the yield of long-term bonds, short-term bonds and municipal bonds seem like good options for investors. However, those who are in lower-to-middle tax brackets may want to instead consider corporate bonds or Treasury bonds. Municipal bonds have slightly lower yields, comparatively, pre-tax.
Evaluate whether municipal bonds are right for you
If you have questions about whether municipal bonds would be a good addition to your portfolio based on your tax bracket, risk tolerance, and other factors, we are happy to discuss your options. Contact us today to discuss your personal financial situation and which bond option may be right for you.
Sincerely,
The Team at Chatterton & Associates
Although the information has been gathered from sources believed to be reliable, it cannot be guaranteed. Federal tax laws are complex and subject to change. This information is not intended to be a substitute for specific individualized tax or legal advice. Neither Royal Alliance Associates, Inc nor its representatives provide tax or legal advice. As with all matters of a tax or legal nature, you should consult with your tax or legal counsel for advice.
