Worried About Your Retirement Tax Bill? Here's an Investment Worth Looking At

For many retirees, the biggest surprise isn't how much they spend in retirement. Rather, it's how much of their income still goes to taxes.

Not only can Social Security benefits be taxable, but if you have your savings in a traditional IRA or 401(k), your withdrawals will be taxable, too. Plus, at some point, required minimum distributions (RMDs) will come into play with a traditional IRA or 401(k), potentially pushing your income and taxes higher than expected.

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If your goal is to generate steady retirement income without having to lose a chunk to taxes, there's one investment you may want to focus on.

How municipal bonds can help reduce your tax burden

Municipal bonds are issued by states, cities, counties, and other local government entities to fund public projects like schools, roadways, and utilities. As with other bonds, you're paid interest at regular intervals, which could allow for more income predictability at a time when you might need it.

The key benefit for investors is the tax treatment, though. Municipal bond interest is exempt from federal taxes. And if you invest in bonds issued by or in your home state, you may also avoid state and local taxes, too.

If you have a portfolio of CDs paying you $12,000 a year in interest, that interest is taxable -- and at ordinary income tax rates, too. With a municipal bond portfolio, that same $12,000 would be yours to keep in full, at least from a federal tax standpoint.

Municipal bonds can be especially advantageous for retirees in higher tax brackets -- which you may end up in once RMDs begin. So if you're looking for predictable income without the tax hit, municipal bonds are worth considering.

The trade-offs to keep in mind

Of course, municipal bonds aren't a perfect solution for everyone. Like all fixed-income investments, they come with interest rate risk -- meaning, bond prices tend to fall when interest rates go up.

You should also know that municipal bonds tend to offer lower yields than corporate bonds. However, corporate bond interest is taxable. If you're in a higher tax bracket, your overall return on a municipal bond may be higher than with a corporate bond once you factor in what you're saving on taxes.

All told, municipal bonds are a smart option for retirees who are looking to minimize their taxes while locking in steady income. So you may want to incorporate them into your investing strategy during retirement -- especially if you're tired of the IRS getting its hands on your money.

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