Tax-Free Passive Income: The Time to Lock in Rates is Now
- Ryan Seewald
- Mar 24
- 3 min read
A common topic of conversation with clients is the want and need for a passive income stream. Whether you’re a retiree, approaching retirement, or someone younger who wants to be risk-averse with a portion of their savings, the question, “where and how can I generate a passive income stream?”, is one that always comes up in conversations. The “when” is one that often doesn’t. In our opinion, the “when” is now. Although it may be a poor time to borrow (mortgages, car loans, etc.), there hasn’t been a better time to lock in rates to earn income in decades.
A few of the most common ways we hear from people about earning, or looking to earn, passive income are things like CDs, high-yield savings accounts, and annuities (just to name a few). In our opinion, the best way to earn passive income is through individual bonds. If managed correctly, individual bonds can give better flexibility, liquidity, and potential tax-efficiency than most income-generating investments.
Tax-efficiency is a key pillar of structuring a portfolio properly. One of our main goals when managing a portfolio is to make sure a client pays the government the least amount as legally possible. For clients that are looking to earn income, tax-free municipal bonds are an integral part of how we do so. Tax-free municipal bonds pay income that is not taxed at the federal level, and if you happen to own bonds that are issued from the state you reside in, the income is tax-free at the state level as well. High-quality municipal bonds are currently paying anywhere between 4-5% right now. For someone that is in the highest tax bracket and resides in a high-income tax paying state (such as New Jersey), 5% could equate to close to 9.5% on a taxable-equivalent basis. What I mean by that is that same person would need to find a CD, savings account, or annuity that pays them roughly 9.5% to net the same amount of income the tax-free municipal bond would. Also, because the income is tax-free it can also potentially help lower your overall tax bracket.
A question that often arises when talking about municipal bonds is “how safe of an investment are they?” From a default standpoint (the risk of you not receiving your principal back), US Treasuries (which are “risk-free”) are the only safer investment from a statistical standpoint. In fact, a AAA rated tax-free municipal bond has never defaulted in history. That said, there is nothing in the entire investment landscape that can currently give you close to 9.5% (on a taxable equivalent basis) with such minimal risk.
What most people don’t realize about most high-quality individual bonds is their liquidity. Most think that once you buy a bond, you have to hold it to maturity. Truth is quite the opposite, and tax-free municipal bonds are no different. You can sell a tax-free municipal bond at any point. Prices can of course fluctuate if you sell prior to maturity, but they are incredibly liquid if you ever need access to cash.
This is just one area that we believe every single investor looking for income-producing investments should be considering. Interest rates remain too attractive not to be taken advantage of when it comes to producing a passive income stream for yourself. Our belief is that rates have already peaked and will be substantially lower 12 months from now. The current interest rate environment has created a rare 'sweet spot' for income-seeking investors, but if our outlook is correct, these yields won't stay at these levels for long.
In a landscape where 'safe' yields are often eaten away by taxes, tax-free municipal bonds remain one of the most powerful tools in a wealth management toolkit. At BPW, we specialize in helping clients capture these efficiencies to maximize their spendable income. If you’re ready to stop paying the government more than necessary and want to lock in these historic rates, reach out to us today. Let’s start a conversation about securing your passive income future.
