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After a tough time for municipal bonds, also known as municipal bonds, investors may be coming back. But there’s a hidden tax retirees need to consider before committing.
While weekly inflows for U.S. municipal bond funds have been negative for most of 2022, outflows have fallen significantly over the past week, according to data from Refinitiv Lipper, signaling interest in higher yields and the credit strength.
Muni bonds generally avoid federal interest taxes and can bypass state and local levies, depending on where you live, which enhances the appeal of high earners.
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However, municipal bond interest can create a problem for wealthy investors: increases in health insurance premiums.
“There are a lot of moving parts, and you have to have someone look at them holistically,” said Matthew Chancey, certified financial planner at CoastalOne in Tampa, Florida.
While interest on tax-exempt municipal bonds can be attractive, that income can raise Social Security taxes and health insurance premiums, said Tracy Sherwood, CFP based in Williamsville, New York, at Sherwood Financial Management.
This is because the formulas of Social security contributions and Health insurance part B and Medicare Part D use what’s called modified adjusted gross income, or MAGI, which includes interest on tax-exempt municipal bonds.
If half of the Social Security plus MAGI payments are greater than $44,000 for a joint tax filing ($34,000 for single filers), up to 85% of the Social Security benefits may be taxable.
But with relatively low thresholds, it’s hard for some high-income retirees to avoid paying taxes on 85% of Social Security payments, Sherwood said.
The biggest problem is that retirees whose income exceeds certain thresholds may owe a supplement for Medicare Parts B and D, known as the Monthly Income-Related Adjustment Amount.
The base premium amount for Medicare Part B in 2022 is $170.10 per month, a jump of 14.5% from 2021. However, payments are starting to increase for joint filers with MAGI over $182,000 (single filers over $91,000).
“This is where you look [Medicare Part B] premiums go up about $70 or more a month,” Sherwood said. “It’s quite important.
The top Medicare Part B supplement is $578.30 for couples filing with MAGI at $750,000 or more.
Retirees may also see premium increases for Medicare Part D, which generally covers prescription drugs, with the highest premium at $77.90 for highest earners in 2022.
Both calculations use MAGI two years prior, so retirees should consider income implications in advance, Sherwood said.
“It’s something taxpayers seem so aware of because if they get into that upper bracket, they have to pay higher premiums for a full year,” said Mary Kay Foss, CPA and CPA professor. at the CalCPA Education Foundation in Walnut Creek, California. .
Additional taxes and bonuses don’t mean retirees should avoid investing in municipal bonds. However, they may consider weighing the pros and cons of tax-exempt interest with a financial advisor.
“There is no right or wrong product,” Chancey said.
Retirees should assess every investment in its entirety — including risk, return, growth potential, tax implications, creditor protection and more, he said. “I look at every investment and ask myself this question, ‘Is the juice worth it?'”