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Get Safe Income in Retirement, As the Tax Vultures Circle

Now that Trumpcare is dead again, the new hot topic dominating the news is tax “reform,” which is prompting many individual investors to nervously overhaul their portfolio strategies. But when a pundit or government official appears on cable television to prattle on about tax policy, I suggest that you just take a deep breath. And hit the mute button.

You also should start shielding income now, through timeless dividend plays that will survive the brewing tax wars. Below, I highlight three tax-related investments that will protect as well as enrich your dividend portfolio.

President Trump this week has been touting the GOP’s nascent tax proposals in speeches around the country, arguing that they would help average American workers and stimulate economic growth.

However, Trump and the Republicans have offered no measure of the costs and details have been sketchy. What’s more, the nation’s capital is riven by intense political animosity, not just between Democrats and Republicans but within the GOP itself. If any legislation actually passes, it will significantly diverge from existing proposals.

Neither political party has offered any sensible options. As the tax vultures gather overhead, don’t trust their intentions.

Win two for the Gipper…

The last two times the U.S. enacted major tax reform was in 1981 and 1986, when “The Great Communicator” was in the White House.

During the 1986 effort, I was a daily newspaperman in the Washington, DC bureau of The Orlando (Florida) Sentinel. I covered the legislative wrangling on Capitol Hill and was able to witness firsthand the horse-trading necessary to get a complex tax bill through Congress and onto the president’s desk.

The chairman of the pivotal House Ways and Means Committee, Dan Rostenkowski (D-IL), was a force of nature whose powers of persuasion and mastery of protocol rivaled that of Lyndon Johnson. The result: sweeping new rules that still dominate the tax code today.

The Tax Reform Act of 1986 simplified the income tax code and eliminated many tax shelters. It was the second of the two Reagan tax cuts, with the Economic Recovery Tax Act of 1981 being the first. Both bills are credited with boosting the economy, although not necessarily the stock market.

Fast forward to 2017. Let’s look at today’s Republican tax plan, as it exists so far.

Trump and the GOP seek to lower individual tax rates by cutting the top rate from 39.6% to 35% and reducing the number of total rates from seven to three. For corporations, the top tax rate would be slashed to 15%, considerably below existing top rates.

The GOP also is determined to eliminate the estate tax (they prefer to call it the “death tax”), which is imposed only on inheritances of more than $5 million.

Missing from the table are measures such as a reduction in payroll taxes, even though most Americans pay more payroll tax than income tax. Nor have any proposals surfaced that would help ordinary investors, especially those living on income-paying investments. In addition, the proposals would generally hurt middle-class Americans by eliminating many of the deductions they’ve come to rely on.

According to the nonpartisan Urban-Brookings Tax Policy Center, Trump’s latest proposals would cut taxes by $6.2 trillion over the next decade, with nearly 50% of all cuts going to the top 1%. I’m not Carnac the Magnificent, but I can psychically divine at least one thing: Democrats will never go along.

Shielding your income…

I hate paying taxes; I assume you do, too. Everyone wants a streamlined, fairer and less burdensome tax code. But unless you have Gucci-clad tax lobbyists at your disposal, you need to take control of your own tax destiny.

Autumn is the time to start planning your taxes. Profitable investors will be looking at their 1040s and noticing that their healthy gains during this bull market also mean a bigger wad of money is going to the IRS. Which brings me to municipal bonds.

Municipal bonds have performed well in light of existing market conditions. With all the uncertainty in the stock market lately, you should be looking for steady, dividend-paying investments to bring ballast to your portfolio, which is exactly what the right bonds can provide. By investing in a basket of municipal bond funds, market volatility is less likely to wreak havoc on your nest egg.

Also consider current Federal Reserve policy, which is getting more hawkish. Rising rates translate into higher government bond yields, which makes the risk/reward ratio for dividend-paying stocks less attractive to investors. But high-income choices still exist, if you know where to look.

Several interrelated trends are making municipal bonds look better and better. Below, I spotlight three highly rated muni choices that will generate robust and safe income, regardless of the latest tax reform fever in Congress. First, a quick refresher course.

Municipal bonds, aka “munis,” are IOU’s issued by city, county, and state governments to raise funds for community projects such as highways, schools, firehouses, or hospitals.

Their chief appeal is that the interest paid to the owner of a municipal bond is exempt from federal taxes. Typically, an investor also is exempt from state taxes if he lives in the same state in which the municipal bonds were issued. What’s more, tax-exempt bonds help diversify a portfolio of stocks and taxable bonds.

To obtain fairly healthy tax-exempt income while minimizing risk, you should focus on intermediate-term bonds with maturities in the range of 10 to 20 years. Shorter-term bond yields are skimpy and longer-term bonds are extremely sensitive to rising rates.

Let’s examine the recent developments that are making muni bond funds wise choices for steady income.

Year-over-year growth in U.S. gross domestic product (GDP) has been healthy so far in 2017. The U.S. Commerce Department reported on Thursday that GDP grew 3.1% in the second quarter, as strong job growth, rising home prices and a booming equity market encourage consumers spend. The economy is expected to maintain this pace in the third and fourth quarters.

U.S. GDP growth this year is modest by historical standards but still robust enough to buoy state tax receipts. An increasing number of states have maintained or secured improved credit ratings, prompting most analysts to issue generally upbeat assessments about the credit quality of U.S. states.

The Best Intermediate-Term Bond Funds Now

Your best bets are the three intermediate-term bond funds below, which tend to weather the sort of volatile market we’re seeing today. They’re all highly rated, with low expense fees.

  • Fidelity Intermediate Municipal Income (NSDQ: FLTMX)

With assets of $5.97 billion, the fund yields 2.58% and has generated a year-to-date return of 3.54%. Over the past five years, FLTMX has generated a return of 2.37%. The fund charges fees of 0.35%. Morningstar gives the fund a three-star rating.

  • Rowe Price Summit Municipal Intermediate (NSDQ: PRSMX)

With assets of $4.79 billion, the fund yields 2.54% and has racked up a year-to-date return of 4.31%. Over the past five years, PRSMX has generated a return of 2.76%. The fund charges fees of 0.50%. Morningstar gives the fund a four-star rating.

  • Vanguard Intermediate-Term Tax-Exempt (NSDQ: VWITZ)

With assets of $55.34 billion, the fund yields 2.70% and has racked up a year-to-date return of 4.70%. Over the past five years, VWITZ has generated a return of 2.85%. The fund charges low fees of 0.19%. Morningstar gives the fund a four-star rating.

 

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