America's favorite break
Ordinary people like you do get one goodie: municipal bonds. Income from munis, which are used to finance roads, schools and other public works, is tax-free and not subject to the AMT (unless it's from so-called private activity bonds that sponsor projects such as airports and stadiums).
Invest your entire wad in the right kind of munis and you can wipe out your income tax bill when you live off your savings in retirement (earn too much, though, and your Social Security may be taxed).
Dick Joslin, 65, a retired ad executive, and his wife Jean, 55, an art therapist, with the help of their Lawrenceville, N.J. financial planner and neighbor Ken Weingarten, have used municipal bonds to lower their tax bill to zip for the past two years, even though, says Dick, "We didn't set out to pay zero taxes as a big objective."
In 2007 both earned small incomes - Dick from a pension and Jean from working part time. (Although they showed their return to Money Magazine, the Joslins asked us not to disclose any figures.) But 80% of their income came from a pool of munis they'd bought after selling their share in a Manhattan brownstone.
Deductions for their property taxes and a large contribution to a charitable donor-advised fund zeroed out any tax they might have owed on their small income. Weingarten expects the Joslins to enjoy two more years of no federal taxes. At that point, they will have to start withdrawing from an IRA, which will give them taxable income.
Can You Do This? You can go whole hog on an all-muni portfolio, but be warned that you may have to settle for pokey returns. Today a triple-A-rated five-year municipal bond pays 3.2%. True, that's a better after-tax yield than you'd get on Treasuries, assuming you're in the 28% tax bracket or higher.
Trouble is, most retirees need more growth than an all-muni portfolio can provide. With decades of retirement ahead of you, you should have as much as 60% of your assets in stocks.
What's more, the tax-free muni strategy works only if you hold your bonds until maturity. If you sell earlier and rates have fallen since you bought, you'll incur capital-gains taxes on the profits.
