I wrote two articles for the MFO newsletter this month. One is on municipal bond funds. Columbia Threadneedle Investments just published an article, "Municipal Bond Outlook". The author's conclusion which I agree with is:
"Historic tax-equivalent yields alone are a good enough reason to consider allocating into municipal bonds. Doing it in the current yield environment also allows investors to pursue a longer-term buffer against the potential for falling interest rates or the impacts of a recession."
https://seekingalpha.com/article/4631914-municipal-bond-outlook-we-think-positive-performance-will-continueMy article evaluates several quality municipal bond funds.
Comments
The Columbia piece: It seems to be industry standard, given that they're trying to sell something, but the maximum tax-equivalent yield of a muni is misleading as the only yardstick offered. To elucidate the obvious, investors need to run their own numbers based on their marginal tax rate to get their very own equivalent yields for a given fund before getting too excited about it.
All depends on what interest rates do which depends on hard or soft landing or "no landing". Long term muni funds like VWLTX are down 3% or so this year. They pay about the same so if interest rates don't go up you may be whole in a while.
Given the various state tax rates and laws, and federal brackets, Medicare 3.8% surcharge everybody's situation is different.
I am leery of articles like This Columbia one. touting a vague "tax equivalent yield" because one size does not fit all.
Don't forget, also ( which I am sure you didn't) that tax exempt dividends are added back to AGI in calculating the Medicare B premiums.
Thanks for the clarification of your situation, @lynnbolin2021. Of course all of us have individual situations that can make any specific investment a go or no-go.
The funds that I write about in the article generally have high quality since the possibility of a recession next year is high.
Most of my money is in tax advantaged accounts which use taxable bond funds and ladders. Munis are more suited for taxable bond funds. RMDs and Roth conversions can push some people into higher tax brackets or impact Medicare Premiums. The Munis that I cover are exempt from Federal Taxes. I invested in one that invests in the state that I live in and is also exempt from state taxes.
Say you're at the top of the 12% tax bracket. By assumption any extra taxable dollars will be taxed at 22% and there are no other effects.
As tarheel observed, with current yields one would be better off investing in a taxable fund and getting taxed at 22% than investing in a muni fund. Even if those extra taxable dollars are what's bumping you into the higher 22% bracket.
Likely getting pushed into the 24% bracket is also not enough to make munis attractive today. The 32% bracket would be a different story.
For example, comparing sma3's VWLTX (SEC yield 3.84%) with VWESX (SEC yield 5.25%), the latter yields 3.99% after tax @ 24%. Taxable bonds still "win" (disregarding other concerns like IRMAA).
However, if you get the same net income (after taxes) from a taxable fund and a muni fund, the muni fund looks better from an IRMAA perspective.
For example, and to simplify arithmetic, suppose you're in a 25% tax bracket. A taxable bond fund yielding 4% returns the same amount after-tax as a muni bond fund yielding 3%.
$100 invested in the taxable fund generates $4 of income (gross), while generating just $3 of income in the muni fund. The latter is better in terms of IRMAA.
Even in a 22% bracket, it might be worth taking the $3 tax-free from the muni fund instead of going for $3.12 after- tax return from the taxable fund. You give up a small amount (12¢) of net (after-tax) income with the muni fund but reduce gross income by much more ($1).
That could make the difference between owing IRMAA and staying below its threshold.
Below are the Income Adjustments (2023) based on the Modified Adjusted Income including tax exempt income for Medicare known as IRMAA. Couple is calculated on an annual basis. Note that if one's MAGI crosses the $194,000 threshold, IRMAA for a couple goes up by $1,874 for a couple for that year. Crossing the $306,000 and $366,000 thresholds increases a couple's IRMAA by $5,669 for the year.
Part B Part D
Individual Individual Couple Incremental
0 $164.90 $ 0.00 $ 3,958
194,000 $230.80 $12.20 $ 5,832 $1,874
246,000 $329.80 $31.50 $ 8,671 $2,839
306,000 $428.60 $50.70 $11,503 $2,832
366,000 $527.50 $70.00 $14,340 $2,837
750,000 $560.50 $76.40 $15,286 $ 946
Below are the Federal Tax thresholds (2023). There is a jump from 24% to 32% by crossing the $340,100 threshold.
Lower Upper Marginal
$ 0 $ 20,550 10%
$ 20,550 $ 83,550 12%
$ 83,550 $178,150 22%
$178,150 $340,100 24%
$340,100 $431,900 32%
$431,900 $647,850 35%
$647,850 + 37%
Optimizing a Roth Conversion probably means converting as much as possible because the IRMAA decreases above $750,000 and the federal tax rates increase by small increments above $340,100. However, when you take into account the additional taxes that have to be paid for both Federal Taxes and IRMAA it becomes more of a cash flow constraint. As a recent retiree, I have three years before Federal Tax rates sunset, and four years until reaching 72. This three-to-four-year window is the optimum time to do Roth Conversions. Using municipal bonds, tax-efficient accounts, tax loss harvesting, and deferring Social Security are useful methods for targeting Federal and Medicare thresholds.
- RMDs now begin at age 73, giving an extra "golden year".
- Several states give capped exclusions for retirement income including conversions; this is a consideration in deciding whether to exhaust the Trad IRA (via conversions) or spread out conversions & withdrawals past age 73 to benefit from lower (state) taxes.
https://rpea.org/resources/retirement-information/pension-tax-by-state/
(See, e.g. Arkansas and Colorado; there are others.)
- Couples are often (usually?) not the same age. So a couple may be assessed a single IRMAA surcharge (if only one person is on Medicare) while still getting the benefit of broader (couple) tax brackets. This effectively halves the impact of IRMAA.
For example, in the first IRMAA bracket, a couple (same age) would pay $1874 more, while being able to increase income by $52K before crossing into the next bracket. That's an effective surcharge rate of 1874/52,000 = 3.6%.
Similarly, a single would pay half as much IRMAA, while being able to add only half as much income before reaching the next IRMAA level, so the single would also have an effective surcharge rate of 3.6%. But a couple with one IRMAA would pay just $1874 more while being able to add $52K of income, for an effective surcharge rate half as much, "just" 1.8%.
- RMDs aren't necessarily subject to tax. They can be used for QCDs. If the T-IRA balance is low enough that RMD does not exceed cash needs plus intended charitable contributions, there is less value in converting more (especially if the additional amount pushes income into a higher tax bracket).
- Cash flow is a limiting factor, though the broader constraint is the amount of cash available, regardless of whether it comes from income or taxable account assets. The object of the game, so to speak, is to move everything into tax-sheltered accounts.
Once taxable assets are consumed, there is less value in doing further conversions.
Optimizing a Roth Conversion probably means converting as much as possible because the IRMAA decreases above $750,000 and the federal tax rates increase by small increments above $340,100
It is true that taking a big IRMAA hit one year is better than taking smaller IRMAA hits in multiple years, all else being equal. The problem is that converting more in higher brackets can subject that conversion income to taxes (aside from IRMAA) that are much higher than they would be if spread out over multiple years.
It may be better to convert a little bit each year even before the "golden years", and then increase the conversion amounts as income drops in retirement. This is especially true if one is comparing small conversions at one's working year tax rate with a one-time conversion getting taxed at an even higher rate.
IOW, it can be rather painful to take a one-time hit in a 32%-37% bracket, especially compared with paying taxes at 22%-24% for several years of conversions (whether while working or in retirement).
You would think there would be a nice spreadsheet to calculate the long term outcomes of various conversion amounts.
I can't find one. My daughter and I tried to write one but it gets more complicated than our feeble Excel talents could handle at least in a quick walk though
2023 tax brackets: married, filing jointly
Tax rate Taxable income bracket Taxes owed
10% $0 to $22,000 10% of taxable income.
12% $22,001 to $89,450 $2,200 plus 12% of the amount over $22,000
22% $89,451 to $190,750 $10,294 plus 22% of the amount over $89,450
24% $190,751 to $364,200 $32,580 plus 24% of the amount over $190,750
32% $364,201 to $462,500 $74,208 plus 32% of the amount over $364,200
35% $462,501 to $693,750 $105,664 plus 35% of the amount over $462,500
37% $693,751 or more $186,601.50 plus 37% of the amount over $693,750
Link to Information Source
However, conversion amounts are not directly subject to the Medicare surcharge. Though the surcharge may still indirectly affect taxes owed. Kitces explains this better than I could. (Well, in more gory detail than I care to provide, anyway
https://www.kitces.com/blog/how-ira-withdrawals-in-the-crossover-zone-can-trigger-the-3-8-medicare-surtax-on-net-investment-income/
The complexity of this surcharge alone illustrates why building a spreadsheet that handles the short term effects of one rule is difficult, let alone a spreadsheet showing long term effects or the interplay between different rules.
While complicated, it is still just math. My problem with building spreadsheets is trying to copy the formulas correctly.
See "Application to Individuals" section of https://www.irs.gov/instructions/i8960
Thanks for the link. complicated but not as bad as it looks unless most of your income is NIIT
I included a Figure #1 in the August 2022 issue that calculated Federal Taxes Plus Medicare Premiums + the Net Investment Income Tax. The spreadsheet was easy for my particular circumstances. My intent was to estimate the optimum Roth Conversion.
https://www.mutualfundobserver.com/2022/08/retirement-planning-in-the-shadow-a-recession/
I started to update the spreadsheet to be more generic, but as @msf said, Here is a document describing how to calculate how much of Social Security Benefits are taxable:
https://www.irs.gov/pub/irs-pdf/p915.pdf
Here is an article describing how IRA withdrawals may impact the NIIT.
https://www.kitces.com/blog/how-ira-withdrawals-in-the-crossover-zone-can-trigger-the-3-8-medicare-surtax-on-net-investment-income/
Here are the Medicare Premium rates:
https://www.medicare.gov/Pubs/pdf/11579-Medicare-Costs.pdf
As I started to update my spreadsheet to be more generic, it became complex. What I decided was to look for a spreadsheet much like you are looking for. What I found is a Spreadsheet that contains templates needed to complete the 1040 and follow the instructions in the 915 document. I downloaded the spreadsheet and it is comprehensive, although most is not relevant to me:
https://sites.google.com/view/incometaxspreadsheet/home/download
One note is that the spreadsheet only has 15 formulas. It uses several hundred named ranges and it will be helpful but perhaps not necessary to know how these work. The spreadsheet is protected so you can't modify the existing formulas, but you can add a sheet and write new formulas.
My approach will be to replicate my latest taxes to get familiar with the forms and then update it for this year. The final step will be to add in a sheet on Medicare Premiums. I can then play what if scenarios.
Cheers,
Lynn
https://www.cnbc.com/2020/02/26/chamath-palihapitiya-esg-investing-is-a-complete-fraud.html
https://blogs.lse.ac.uk/businessreview/2023/01/31/marketing-is-killing-esg-heres-how-we-can-save-it/#:~:text=ESG%20is%20certainly%20not%20a,get%20from%20its%20true%20meaning.
But infrastructure ≠ ESG. (Hard to see how a Yankee Stadium muni bond is ESG.)
Here's a 1932 ad for munis to support construction damming Hetch Hetchy (part of Yosemite National Park), and John Muir's writing about the valley and the then proposed dam. https://vault.sierraclub.org/john_muir_exhibit/writings/the_yosemite/chapter_16.aspx
The Sierra Club echoed that last line in its successful campaign against similarly damming the Colorado River at both ends of the Grand Canyon. "“Should we flood the Sistine Chapel, so tourists can get closer to the ceiling?”
https://energyhistory.yale.edu/sierra-club-grand-canyon-dam-advertisements-1966/
If you're interested in green bonds, that's a different matter. Here's a 10 minute background video from CNBC on green bonds.
https://www.cnbc.com/video/2021/05/28/green-bonds-growing-part-trillion-bond-market-how-they-work.html