When President Clinton's tax bite comes, it will sink deepest into high-income earners. Investing in municipal bonds issued by your own state or city can exempt you not just from federal taxes but from local levies as well. Even in such battered states as California and Connecticut, munis can be a secure bet.
Low interest rates are making it desirable for municipalities to issue huge numbers of bonds this year. To attract investors to this oversupply, issuers are offering fairly high yields--about 6%. To get that return on a taxable investment, you'd need one paying 8.7%--which could mean taking considerable risk. With munis, however, the risk of default is extremely low: less than 0.5%. More commonly, bonds get downgraded, causing their market prices to drop. But that would affect you only if you had to sell. And if the bonds are highly rated to begin with, the tax advantages might still outweigh such a risk.
STILL SOUND. Clinton's plan calls for hiking the top federal rate on married couples with $140,000 in income to 36%, from 31%. Those making $250,000 or more would pay 39.6%. In New York and California--two states with high taxes and many high-income earners--the sting will be worse. In San Francisco, the triple tax will jack up the top rate to more than 50%--making the in-state muni more valuable than ever.
When shopping for buys, realize that even in states with major fiscal woes, many munis are safe. A lot of issues are insured and thus rated AAA by Moody's Investors Services and Standard & Poor's. AA and A ratings can be just as sound if you study the underlying fundamentals, says James Cooner, bond manager at Bank of New York.
Another option is to invest in single-state, muni mutual funds. These provide double and triple exemption along with diversification, liquidity, and professional management. For example, Franklin Group's California fund, says Thomas Kenny, manager of muni research, yields 6.1%, or a top in-state tax-equivalent 10.25%.
In states with a high concentration of affluent taxpayers, there are numerous individual bonds that look good. California's crippled economy has pushed its rating from Aaa/AAA in 1991 to Aa/A+, says William Fish, an analyst at Donaldson, Lufkin & Jenrette Securities. But he likes bonds from the California Water Resources Dept. and Metropolitan Water District of Southern California anyway, since the service they provide, supplying water to the southern part of the state, is so vital.
Connecticut may still suffer from defense cuts, but a bond that could evade the state's new 4 1/2% income tax is an A1/AA Special Tax Obligation Transportation Infrastructure issue yielding 5.10%, says Howard Sitzer, director of municipal bond research at Greenwich Partners. These are "very strong" because they're backed by taxes on registrations, licenses, and gasoline.
New Jersey has weakened along with its region, and its general-obligation bonds have been downgraded, from Aaa/AAA to Aa1/AA+. But it has a high-income base, says Sitzer, and "strong economic diversification." He likes New Jersey Turnpike Authority bonds because the highway is crucial to the Northeast transportation corridor.
BOMB FACTOR. Taxpayers in both New Jersey and New York can benefit from Port Authority of New York and New Jersey bonds, which are yielding 5.65%. These are triple-exempt in New York and double-exempt in New Jersey. DLJ's Fish likes them even though their ratings could suffer as a result of liabilities from the bombing at the World Trade Center. But he says rating agencies are confident insurance will cover the damage. And the Port Authority has two years of principal and interest, as well as bridge, tunnel, and airport fees, backing the bonds.
Illinois residents might look at two creditworthy bonds, says Robert Froelich, director of muni research at Van Kampen Merritt: O'Hare International Airport, a critical hub, and Metropolitan Pier Exposition Authority. Meanwhile, Florida has two attractive utility bonds: from Florida State Municipal Power Agency and Jacksonville Electric Authority, both of which provide key services to growing and diversified areas, says Phil Simonetti at Shearson Lehman Brothers.
Wherever you live, you can find munis with better yields than taxable investments with similar risks. The best part is that no matter how high your taxes go, your interest income is still safe from Uncle Sam.