Are You Considering Your Cash Flow After Paying Uncle Sam?

In today’s climate of heightened market volatility, I know many of you are seeking more stable investment solutions. Unsettled economic policy, uncertain interest rates, and global events have all contributed to an unpredictable environment that can challenge even seasoned investors. My role is to help you navigate these conditions with confidence, offering insights and tailored strategies designed to protect your portfolio while still pursuing long-term growth.

For high-income earners seeking steady income with tax advantages, municipal bonds (“Munis”) represent a powerful and often underappreciated investment choice. At Alpine Hill Advisors, we see these debt securities issued by states, cities, counties, and local government entities as a great opportunity to earn competitive, tax-free income without taking on the credit risks sometimes associated with corporate bonds.

The Key Benefit: Possible Tax-Free Income

One of the key attractions for us is that interest earned on most municipal bonds is exempt from federal income tax. Additionally, if you purchase bonds issued within your state of residence, the interest may also be exempt from state and local taxes.

This is advantageous especially for investors in the top tax bracket while living in high-tax states like New York or California. For example, if you are a NY resident in the top tax bracket you are typically paying nearly a 50% tax rate between federal and state taxes.  

Understanding After-Tax Yields

In today’s current market environment, you can buy a AAA rated NY bond at roughly 4% yield. At first glance, that might seem low compared to a corporate bond which could be yielding 5 ½% to 6%. However, once you analyze the after-tax yield of the corporate bond, compared to the NY municipal bond the after-tax cash flow looks very attractive.

Calculating After-Tax Yield

After-Tax Yield = Stated Yield x (1 – (Federal Marginal Tax Rate + State Marginal Tax Rate)) ¹

Using the above example for a NY resident in the top tax bracket, the 6% corporate bond gives that investor an after-tax yield of approximately 3%, factoring the top federal income tax rate of 37% and additional state and local taxes in the range of 10-12%. Therefore, with all else being equal the Muni has higher yield and retains more cash in your pocket. ²

Additional Advantages of Municipal Bonds

The possibility of a double or triple tax exemption is just one of the advantages for investors. There are other compelling benefits as well:

• Lower Risk Profile: Municipal bonds historically have lower default rates than corporate bonds. According to Moody’s, the 10-year cumulative default rate for investment-grade municipal bonds is less than 0.10%, compared to around 2.3% for investment grade corporate bonds. ³
• Portfolio Diversification: Munis often behave differently than equities and corporate bonds during economic stress, which can help offset current portfolio volatility.
• Flexibility: Investors can build customized Muni portfolios that target specific durations, credit qualities, or geographical exposures — making it easier to align with financial goals and risk tolerance.

Potential Policy Changes and Market Outlook

It is always important to understand that tax policy changes could impact the municipal bond market. Recently, the House Ways & Means Committee presented its budget reconciliation tax proposal. Among several provisions in the bill that are material for municipal investors, the Committee proposed no changes to the municipal tax exemption.

That said, historically there have been several times when the exemption has been on the table. In the 1980s, eliminating exemption was seen as a potential area for savings during congressional debates on federal spending. The financial crisis of 2009 brought the introduction of Build America Bonds (BABs), which were taxable bonds with a federal subsidy. Even the 2017 Tax Cuts and Jobs Act still included provisions that impacted on some municipal bonds. ⁴

Maximizing Your Investment Strategy

When comparing investments, we believe one should always consider their investments’ after-tax return. Investments like municipal bonds can often deliver far more than they initially appear, especially for high-tax bracket investors. At Alpine Hill Advisors, we specialize in building customized municipal bond strategies tailored to your unique tax situation and income needs. It may be one of the most tax-efficient moves you will make in 2025.

Thank you for taking time to read our insights. If you would like to discuss how municipal bonds or any other fixed income strategies could be beneficial to your long-term goals, please feel free to reach out.