- The U.S. municipal bond fund market brought in an estimated $56.9 billion in net new money during the first half of 2021, according to Refinitiv Lipper data.
- These assets may offer tax benefits and low default risk, as well as inflation protection.
- But the tax-exempt interest may trigger higher Social Security levies and Medicare premiums, financial experts say.
Investors are piling into municipal bonds — also known as muni bonds or "munis" — ahead of President Joe Biden's proposed tax hikes. However, some retirees may be hit with a costly surprise: higher Social Security levies and Medicare premiums.
During the first six months of 2021, U.S. muni bond funds brought in an estimated $56.9 billion in net new money, the most for any first half of the year since 1992, according to Refinitiv Lipper data.
With current yields above Treasurys, muni bonds have been attractive to wealthy investors, and typically avoid federal taxes on interest. Moreover, many of these assets scored a credit boost in 2021 as federal stimulus money reached state and local governments.
However, before funneling cash into muni bonds, investors must consider their entire financial situation, according to experts.
"There are a lot of moving parts, and you need to have someone look at it holistically," said Matthew Chancey, certified financial planner at Dempsey Lord Smith in Tampa, Florida.
Although tax-exempt muni bond interest may be appealing, those earnings may increase Social Security taxes and Medicare premiums, said Tracy Sherwood, a Clarence, New York-based CFP at Sherwood Financial Management.
If half of someone's Social Security payments plus MAGI is more than $44,000 for a joint tax return ($34,000 for individual filers), up to 85% of their Social Security benefits may be taxable. Retirees can learn more about the calculation for Social Security taxes here.
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With that relatively low threshold, it's difficult for some higher-income retirees to avoid paying tax on 85% of Social Security payments, Sherwood said.
To make matters worse, those with income above certain thresholds may also owe a surcharge for Medicare Part B, known as the Income Related Monthly Adjustment Amount or IRMAA.
The base amount for Medicare Part B premiums in 2021 is $148.50 per month. However, the payments start to increase for joint filers with MAGI over $176,000 (single filers above $88,000).
"That's where you're looking at [Medicare Part B] premiums going up by about $50 or $60 per month," said Sherwood. "That's pretty significant."
The premiums top out at $504.90 for couples filing together with MAGI at $750,000 or above.
Plus, the Medicare Part B calculation uses MAGI from two years prior, so retirees need to consider the consequences of their income in advance, she said.
"It's something that taxpayers seem so aware of because if they get into this higher bracket, they have to pay higher premiums for a full year," said Mary Kay Foss, certified public accountant and CPA faculty at CalCPA Education Foundation in Walnut Creek, California.
Of course, added taxes and premiums don't mean retirees should steer clear of muni bond investing. However, they may consider weighing the pros and cons of tax-exempt interest with a financial advisor.
"There's no such thing as a good or a bad product," Chancey said.
Retirees need to assess each investment in its totality — including risk, yield, growth potential, tax implications, creditor protection and more, he said. "I look at every investment, and I ask myself this question: 'Is the juice worth the squeeze?'"