Last week, we met with a new client – an investor who was passionate about his municipal bonds. His father had been a “muni guy” and when he’d inherited some of his father’s bonds, he kept the tradition alive. Each time a bond would come due, he would roll the proceeds into a new bond offering to keep up the tax-free income. The problem for our client was that he already had a $10 million net worth when his father passed away. The $8 million bond portfolio he inherited puts him squarely into estate tax danger. His municipal bonds may continue to pay tax-free income while he’s alive, but should he pass away with this portfolio, his heirs would see an inheritance crash the likes of which they’ve never seen before.
The Problems with Municipal Bonds
While municipal bonds may have some traits that make them more desirable than other investments, they are by no means the perfect financial vehicle, especially nowadays.
Estate Tax Issues: Your muni bond portfolio may produce tax-free income while you’re alive, but at your death, those munis are included in your taxable estate. The result can be a massive 40%+ tax that’s imposed on your heirs. If you have a net worth that approaches or exceeds $11.7 million, you should give this risk serious consideration.
Prices are High: With strong investor demand for tax-free income and a lack of high-quality municipal bonds in supply, the price of these bonds continues to push higher. As a result, the rate of return continues to decline. An investor who once received an average return of 5- 7% may now be looking at 3% or less.
Default Risk: We’ve been seeing an increasing number of cases where municipalities are either defaulting on their obligations or reorganizing their bond issues with much less desirable terms for investors. You may sleep easier owning municipal bonds than you would with stocks, but munis are by no means totally risk-free.
Other Risks: There are several other risks municipal bond investors must consider. For one, their entire tax-exempt nature may be at risk. If the government decided to reintroduce a tax on municipal bonds, it would be a big revenue generator. That means this could become a bargaining chip in Washington, especially if the economy continues to struggle and our national deficit continues to grow. Muni bonds are also subject to interest rate, inflation, and liquidity risk, just to name a few.
Life Insurance Offers an Alternative
What if we told you there are options out there that can return nearly 300% more than your municipal bond portfolio? Here’s how you can do it: Let’s say you invested $1 million in a 30-year, AAA-rated municipal bond at 60 years old. Your investment would grow to $2,806,793, assuming you reinvested all of the interest payments and then got back 100% of your principal at age 90. However, if you then died and paid 51.4% in estate taxes ($1,442,692), your heirs would receive only $1,364,101, which is a return of barely 1% per year.
If instead you purchased a Last-to-Die Universal Life Insurance policy, that same premium of $1 million at age 60 could buy a policy with a death benefit of $5,166,982, tax free! This represents a net after-tax gain of $3,802,881 (+278%) over the municipal bond investment.
Life insurance can actually be incorporated in several ways depending on your exact needs. For example, if taking income is a priority, that same $1 million muni bond portfolio can be exchanged for a Single Premium Index Annuity (SPIA). You can take the portion of income needed and the excess income can be used to fund a life insurance policy, which will provide a very substantial tax-free death benefit to your heirs.
There may also be cases where keeping the municipal bond portfolio makes sense but rather than reinvesting the dividends, they can be used to buy life insurance. This would keep some liquid assets available but enhance the inheritance left to your family through the tax-free death benefit.
Find the Solution That’s Right for You
At Howard Kaye Insurance Agency, we have decades of experience creating unique estate planning solutions anchored by life insurance. We’ve helped our clients save millions and millions of dollars by getting them to view their overall portfolio from a different perspective. Call us today at 800-DIE-RICH and we’ll run a free analysis of your municipal bonds and estate plan.
