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Are Munis a Shelter from the Storm? Not so Fast

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The Wall Street Journal reports that Americans in high tax states like New York and California are jumping into municipal bonds to shelter their investments from taxation. Maybe these are residents who can flee from the high tax states they call home, as so many others have. Now that the federal government has stopped subsidizing these states’ high taxation, residents are feeling the full burden of their states’ big-spending ways.

The Journal reports:

Investors in high-tax states like New York and California are piling into municipal bonds this year, fueled in part by the 2017 tax overhaul that raised tax burdens for some high-income households.

The purchases are driven by taxpayers’ desire to generate tax-free income, and this year’s buying surge started right as taxpayers were seeing the full impact of the new law.

Mutual and exchange-traded funds containing California, New York and New Jersey munis have received a combined total of $6.5 billion in inflows this year through the end of July. The inflows marked the most of any seven-month period since at least 2014, according to Lipper. People started completing the first tax returns under the new law in late January and February.

The purchases add to the already-high demand for municipal bonds, pushing up bond prices further and diminishing the benefit taxpayers are seeking. But they also make it easier and cheaper for governments to borrow.

“High-income taxpayers oftentimes were a little bit taken aback by the fact that their tax bills either stayed pretty flat or maybe their aggregate tax bill increased. And that always raises a question of: What can I do about this?” said Suzanne Shier, chief tax strategist for wealth management at Northern Trust Corp.

The vast majority of taxpayers got federal tax cuts under the law, but 12% of those with incomes over $1 million got tax increases.

Tax-free income sounds great, but there are some issues with muni bonds that should be remembered.

First, expected returns on municipal pension funds are too high, leaving pensions underfunded.

Second, with plans underfunded, municipalities will most likely be spending more than expected out of their general budgets to finance future pension payments.

Third, there’s only so much money available to states and cities. Dangerously underfunded pensions could end up competing with munis for the scarce tax revenue, especially if cities go bankrupt. That’s a great added risk for investors.

Remember to fully recognize the risks of any investment before you lay down your hard-earned money.

Originally posted on Your Survival Guy. 

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E.J. Smith

Editor-in-Chief
E.J. Smith is Founder of YourSurvivalGuy.com, Managing Director at Richard C. Young & Co., Ltd., a Managing Editor of Richardcyoung.com, and Editor-in-Chief of Youngresearch.com. E.J. graduated from Babson College in Wellesley, Massachusetts, with a B.S. in finance and investments. In 1995, E.J. began his investment career at Fidelity Investments in Boston before joining Richard C. Young & Co., Ltd. in 1998. E.J. has trained at Sig Sauer Academy in Epping, NH. His first drum set was a 5-piece Slingerland with Zilldjians. He grew-up worshiping Neil Peart of the band Rush, and loves the song Tom Sawyer—the name of his family’s boat, a Grady-White Canyon 306. He grew up in Mattapoisett, MA, an idyllic small town on the water near Cape Cod. He spends time in Newport, RI and Bartlett, NH—both as far away from Wall Street as one could mentally get. The Newport office is on a quiet, tree lined street not far from the harbor and the log cabin in Bartlett, NH, the “Live Free or Die” state, sits on the edge of the White Mountain National Forest. He enjoys spending time in Key West and Paris. Please get in touch with E.J. at ejsmith@youngresearch.com.