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Q

I was under the impression that a tax-free municipal was just that – tax free. However, I have learned that if you are in the position that your social security benefits are taxable, any tax-free income is included when figuring your tax liability. What, if any, would be the advantage of a muni bond when there are so many other choices with better returns at shorter-time terms?

A

James A. Klotz responds:

Tax-free income is included in the computation for determining the taxability of your social security benefit, but is not included in the calculation of your federal tax liability.

Although you do not specify what other sources you are referring to, they will not provide higher after-tax yields for high-tax bracket investors.

Further, shorter securities will not allow you to rely on this higher income for more than a short period of time. When these securities come due, you will likely be unable to replace the income. We are concerned that higher yielding short-term investments make our investors vulnerable to “income risk.”