Municipal Bonds in Tax Advantaged Account

Investing Strategies Bonds & Fixed Income Investments
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I have been diversifying my portfolio over the past year as I get closer to retirement (less than 4 years until full-retirement-age). I was about 95% equities this time last year and have gotten closer to 60/40 at this time. My fixed income investments have primarily been CDs, Corporate Bonds, and Agency/GSE bonds. I have been researching Muni Bonds to purchase in my taxable account that would avoid Federal income tax, and I have seen some with pretty good yield-to-maturities. The catch, I have learned, is the IRS’ de minimis rule on deep-discounted bonds.

My thinking is that it wouldn’t make sense to buy a Muni in a tax advantaged account if the bond is purchased at or near par value; however, it may make sense to buy a deep discounted Muni in a tax advantaged account to avoid the ordinary income taxation from the gains resulting from the discount.

Why buy a Muni with a 2% coupon in a tax advantaged account but oh wait that 3.5% of the YTM (since buying at a discount) will not be taxed as ordinary income.

Anybody have any thoughts or suggestions to share? Always appreciate the Fool Feedback.

1 Like
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When you say tax advantaged account do you mean Roth IRA. If yes not much point in putting muni bond there. You can get better yield on a corporate bond of the same grade and maturity and pay no income tax.

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Well, it depends on what type of ‘tax-advantaged account’ you are talking about. Buying it in a Roth account - yes, if you meet the requirements for qualified distributions, you will avoid any taxes on the distribution. But buying it in a Traditional account would mean that all distributions are taxed at ordinary income rates, so you (or your heirs) would eventually pay ordinary income taxes on not only the discount, but the original purchase price.

Again, only in a Roth account.

I generally try to put my expected highest return investments into Roth accounts. Since munis, even when purchased at a discount, are generally not expected to have a high return when compared to most other investments, this strategy wouldn’t meet my criteria.

AJ