Are Municipal Bonds Right for Retirees?
Retirees should not hold municipal bonds in an individual retirement account, according to Phil Cannella, IRA expert.
The tax-free nature of municipal bonds serves as a major incentive for investors looking to hold long-term assets. However, IRAs are classified as “tax-deferred,” meaning investors must pay taxes when taking money out of an account.
“If you place a municipal bond in an IRA, you’ll pay taxes when you cash out of your IRA,” says Phil Cannella. “Municipal bonds work best separate from an IRA.”
Of course, municipal bonds also have risks that many financial advisors do not disclose to investors.
Many retirement planners tout municipal bonds – typically used to help municipalities raise funds to improve roads, construct new schools and improve other key infrastructure – as an incredibly safe investment. However, several cities around the country have run into financial problems.
Harrisburg, Pennsylvania and Jefferson County, Alabama as well as two California cities have all defaulted on bond payments in recent months. And while these defaults only comprise a small portion of the municipal bond market, it goes to show that even so-called safe investments can backfire.
Conduit bonds – a type of municipal bond used to fund private developments like hospital renovations and real estate projects – contain even more risk, according to Phil Cannella. Many financial planners bill conduit bonds as “high-yield” municipal bonds as they usually offer investors higher interest rates compared to traditional municipal bonds. However, most conduit bonds have lower bond ratings as they generate their interest payments by their profits. Conduit bonds also usually do not have any guarantees from any government body that, in case of a default, the investor will receive interest or principal payments.
Some experts estimate that over 70% of all conduit bonds end up defaulting.
“It’s a common misconception that bonds don’t have risk. The truth is that they do have risk, and there is no place for risk in a retirement plan.”- Phil Cannella.
One such incident came from a children’s mental health facility based in the Lehigh Valley known as KidsPeace. The agency issued nearly $75 million in bonds in the late 1990s as part of a construction and refinancing plan. It said it would repay the bonds from revenues generated from treating patients and grant money.
However, several concerns about safety issues and management oversight caused the Pennsylvania officials to investigate the facility. Since then, revenues have fallen, forcing KidsPeace to default on a $1.4 million interest payment this past January.
“The devil is in the details. There are so many hidden risks with municipal bonds that financial planners do not tell clients. There are also safer products out there for retirees,”- Phil Cannella.
FOR MORE INFORMATION FROM PHIL CANNELLA, TUNE IN TO THE CPR SHOW, EVERY SATURDAY 11AM