Comparing Municipal Bonds to Treasury Bonds: Which Is Best for Augmenting Annual Income?

As an investor living in New Jersey and using platforms like Treasury Direct and eTrade, I find myself comparing different types of Bonds to boost Income on a consistent basis. Both Municipal Bonds (Munis) and U.S. Treasury Bonds offer unique advantages, but understanding their differences, risk profiles, and tax implications is key to making informed investment decisions.

In this post, I’ll break down the characteristics of Munis and Treasuries, explain how they pay interest, and explore why a combination of both could be the best strategy for consistent, tax-efficient augmented income.

Understanding Treasury Bonds

U.S. Treasury Bonds are some of the safest investments you can make. They are backed by the full faith and credit of the U.S. government, which has never defaulted on its debt. This safety, however, means that Treasury Bonds typically offer lower yields compared to other types of Bonds, like corporate Bonds or even Municipal Bonds. But in times of economic uncertainty, the reliability of Treasuries can be invaluable. The goal is shifting to augmentation of income over a duration, and Treasuries are a certain option to meet that demand.

Treasury Bonds typically pay semi-annual interest, and all holders of the Bond receive their payments on the same dates. If you purchase a 30-year Treasury Bond at the next auction, for example, you’ll lock in an interest rate (coupon) based on the current market conditions, and you’ll receive interest payments every six months based on the face value of the Bond. As you plan to buy Treasuries incrementally, this strategy can help you build a laddered portfolio, smoothing out any potential interest rate volatility over time.

Treasury Bonds are exempt from state and local taxes, but the interest is subject to federal taxes. This can be a disadvantage if you’re seeking to minimize your overall tax liability, especially if you live in a high-tax state like New Jersey.

Exploring Municipal Bonds

Municipal Bonds (Munis) are issued by local governments, states, and counties, making them slightly more risky than Treasuries, but still generally safe, particularly for AAA-rated Bonds. Munis come in two main varieties: General Obligation (GO) Bonds, which are backed by the full taxing authority of the issuer, and Revenue Bonds, which are repaid from specific revenue streams like tolls or utilities.

Two examples of Muni Bonds you’re considering:

  • Scott County, MN (AAA-rated GO Bond): Maturity in 2034 with a 4% coupon and YTM of 3.408%.
  • Nassau County, NY Interim Finance Authority (AAA-rated Revenue Bond): Maturity in 2034 with a 5% coupon and YTM of 3.29%.

Both of these Bonds pay semi-annual interest, similar to Treasuries, but they offer an important advantage: tax exemptions. Interest earned on Municipal Bonds is exempt from federal taxes, and if you purchase Bonds issued by your home state (New Jersey in your case), the interest may also be exempt from state and local taxes. While the Minnesota and New York Munis you’re considering won’t qualify for New Jersey tax exemptions, the federal tax benefit still makes them attractive.

For investors in higher tax brackets, the tax-free nature of Muni Bonds can provide a higher tax-equivalent yield (TEY) compared to taxable Bonds like Treasuries. For example, a Muni with a YTM of 3.3% might outperform a Treasury Bond with a higher nominal yield, depending on your tax rate.


Augmented Income Strategies: Treasuries (Interval Deposits/Purchases)

When considering strategies to augment income with Fixed-Income Investments, it’s essential to understand how interest is paid on different types of Bonds. For instance, 30-year Treasury Bonds offer a predictable interest payment structure, while Municipal Bonds (Munis) come with their own set of nuances.

Interest Payment Timing for Treasury Bonds

Interest on 30-year Treasury Bonds is paid semiannually, or twice per year, based on the bond’s issue date. If you purchase two bonds at different times, such as in November and December, the interest payments will follow different schedules.

  1. Example:
    • A bond issued in November will pay interest on May 15 and November 15.
    • A bond issued in December will pay interest on June 15 and December 15.

This staggered schedule can be advantageous for creating a steady flow of income if you're purchasing bonds regularly.

Purchasing Bonds at Different Times

If you buy Bonds issued at different points during the year, their interest payments will reflect the timing of the Bond's issuance. For example:

  • Purchasing a Bond in November locks in interest payments every May and November.
  • Purchasing a Bond in December locks in interest payments every June and December.

With this approach, you can plan to receive interest payments at multiple intervals throughout the year, effectively spreading out your income.

Municipal Bonds (Munis): A Different Structure

Municipal Bonds (Munis) are similar to Treasuries in that they also pay interest semiannually. However, their interest schedules vary based on the terms set by the issuing state, county, or municipality. This variability means two Munis purchased at different times will likely have different interest payment dates.

  1. Interest Payment Schedule for Munis:

    • A Muni bond issued in January might have interest payments due on January 1 and July 1.
    • A Muni issued in March might pay on March 1 and September 1.

  2. Two Munis with Different Purchase Dates:

    • A Muni bought in November could have interest payments due in November and May.
    • Another Muni bought in December may pay in December and June.

However, Municipal Bonds tend to have more variables when purchased through a broker, such as eTrade, compared to Treasuries. Different issuers may have varying schedules and terms, including whether the bonds are callable before maturity.

Laddering and Interval Purchases: Treasuries vs. Munis

Treasuries offer a clear advantage for investors looking to implement a laddering strategy on a budget or in planned increments. Treasury Bonds can be purchased in $100 increments, making them accessible for those wanting to invest a fixed amount monthly. For example, you could plan to invest $300 per month in Treasury Bonds for five years, which would provide a regular stream of income and a diversified maturity schedule.

On the other hand, Munis often require higher minimum investments when purchased through brokers. For instance, on eTrade’s bond desk, I see Muni bonds with minimum purchase amounts of $5,000, $10,000, or even $50,000. This higher barrier to entry might limit the flexibility to invest incrementally in Munis compared to Treasuries.

Interval Conclusion

While both Treasuries and Munis provide semiannual interest payments, Treasuries offer greater flexibility for interval purchases and laddering strategies due to their smaller minimum investment amounts. Munis, although potentially offering tax benefits, often come with higher minimums and varying terms depending on the issuing authority. Careful planning is key when deciding which investment strategy best aligns with your income goals and investment timeline.

Risk Considerations: Munis vs. Treasuries

When it comes to risk, Treasuries are virtually risk-free in terms of credit default. The U.S. government has never defaulted on its debt, and unless you sell your Bond before maturity, you’re guaranteed to receive your interest payments and principal back at maturity. I could write a whole new Blog Post on Fiat and how it cannot default but can surely and grossly become devalued over time (Brilliant Monetary System; Imo).

Munis, while also generally safe, do carry slightly higher risk, especially when they are callable—as is the case with the Scott County and Nassau County bonds. Callable Bonds allow the issuer to redeem the Bond before maturity, typically if interest rates fall and they want to refinance at a lower rate. This means that the Bond’s Yield to Worst (YTW) might be lower than the Yield to Maturity (YTM). For the Scott County Bond, for instance, the YTM is 3.408%, but the YTW (assuming it gets called early) is 2.7%. With the Nassau County Bond, the YTM is 3.29%, but the YTW drops to 2.576%.

That said, both of these Munis are AAA-rated, indicating very low credit risk. In a well-diversified bond portfolio, high-quality municipal bonds can still provide a reliable income stream.

Interest Payment Schedules and Income Stability

Both Munis and Treasuries pay interest on a semi-annual basis, making them ideal for investors seeking regular income. Treasury Bonds have fixed payment schedules based on the Bond’s issue date, so all investors in the same Bond receive payments on the same dates. Munis have similar schedules, but their tax-exempt status can make them more attractive for income-focused investors, particularly in high-tax States (Including NJ).

Given that I'm considering purchasing 30-year Treasury Bonds on a regular basis at auctions, this strategy works well for laddering Bond investments. This means I’ll consistently build a portfolio of Bonds maturing at different dates, providing a smooth income stream over time, while reducing interest rate risk or being, "Called".

At the same time, integrating high-rated Municipal Bonds into the portfolio can further enhance the income, especially when considering the tax-exempt nature of Muni Interest. Even though Munis might carry slightly more risk due to their callable nature or reliance on local government finances, the overall safety of AAA-rated bonds makes them a sound choice.

Tax Implications: A Key Factor for New Jersey Investors

Federal Taxes are, to my understanding outside of Puerto Rico, are universal as follows:

2024 Federal Income Tax Rates

For Individual Filers:

  • 10% on income up to $11,600
  • 12% on income over $11,600 to $47,300
  • 22% on income over $47,300 to $110,800
  • 24% on income over $110,800 to $190,550
  • 32% on income over $190,550 to $383,900
  • 35% on income over $383,900 to $487,450
  • 37% on income over $487,450

For Married Couples Filing Jointly:

  • 10% on income up to $23,200
  • 12% on income over $23,200 to $94,600
  • 22% on income over $94,600 to $221,600
  • 24% on income over $221,600 to $381,100
  • 32% on income over $381,100 to $767,800
  • 35% on income over $767,800 to $974,900
  • 37% on income over $974,900​
    Sources: Investopedia AARP
    .

Additionally, the standard deductions for 2024 are:

  • $14,600 for single filers
  • $29,200 for married couples filing jointly​
    Source: Investopedia

For a New Jersey resident, tax considerations are significant when comparing Munis to treasuries. While Treasury Bonds offer State and Local Tax exemptions (S.A.L.T.), you’ll still need to pay Federal Taxes on your interest income. This makes Treasuries less attractive from a tax perspective compared to Municipal Bonds, which are exempt from Federal Taxes and, in many cases, S.A.L.T. as well.

Although the Scott County, MN and Nassau County, NY Munis wouldn’t offer New Jersey state tax exemptions, their federal tax-exempt status still makes them more tax-efficient than treasuries, particularly if you are in a higher tax bracket.

In New Jersey, the State Income Tax is progressive, meaning that rates increase with higher income levels. Here’s a summary of the Income Tax Brackets from the 2023 tax year:

Tax Rates by Filing Status

Single Filers:

  • $0 - $20,000: 1.40%
  • $20,000 - $35,000: 1.75%
  • $35,000 - $40,000: 3.50%
  • $40,000 - $75,000: 5.525%
  • $75,000 - $500,000: 6.37%
  • $500,000 - $1,000,000: 8.97%
  • Over $1,000,000: 10.75%

Married Filing Jointly:

  • $0 - $20,000: 1.40%
  • $20,000 - $50,000: 1.75%
  • $50,000 - $70,000: 2.45%
  • $70,000 - $80,000: 3.50%
  • $80,000 - $150,000: 5.525%
  • $150,000 - $500,000: 6.37%
  • $500,000 - $1,000,000: 8.97%
  • Over $1,000,000: 10.75%

Married Filing Separately:

  • Rates were identical to those for single filers.

Head of Household:

  • The brackets for head of household filers are similar to those for single filers, though they are structured to reflect specific income levels.

Bonds purchased at a discount (Resale in this case) might be subject to capital gains. Because the Bond will be paid at the original value over the current discounts.

Conclusion: A Diversified Approach for Consistent, Tax-Efficient Income

In summary, both municipal bonds and treasury bonds can play a key role in your strategy for consistent income. Treasury Bonds provide unmatched security and can be purchased incrementally to build a laddered portfolio, offering guaranteed payments over time.

Meanwhile, Municipal Bonds offer the advantage of tax-free income, especially for higher-income investors or those in states with high taxes like New Jersey. High-rated Munis like Scott County and Nassau County bonds carry low credit risk and could provide a significant boost to your after-tax income.

By incorporating a mix of AAA-rated municipal bonds and Treasury bonds into your portfolio, you can enjoy a blend of tax advantages, safety, and a reliable income stream. This diversified approach offers the best of both worlds, helping you meet your income needs while optimizing your tax liabilities.

I am leaning heavily towards Treasuries because of the Minimum Investments and current interval opportunities.

Disclaimer: The information provided in this post is for educational and informational purposes only and should not be considered financial or investment advice. While every effort has been made to ensure the accuracy of the data and tax rates discussed, tax laws and financial regulations are subject to change. It is recommended that you consult with a qualified tax professional or financial advisor for personalized advice tailored to your specific situation. The author is not responsible for any losses or damages incurred as a result of reliance on the information presented herein.

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