Want to Beat Boring CDs? Munis Can Be a Conservative Way to Increase Yield
Municipal bonds come with some risks that bank CDs don't, but there are ways to minimize them while still getting a better return. Plus, the interest you earn is tax free, and who doesn't love that?

Often retirees will have excess funds sitting in the bank. Far more than they need for an emergency. And in some extreme cases, they have all their money in the bank because they don't feel comfortable putting it in stock-related portfolios.
The result is that they may spend their golden years struggling to have enough income to live a comfortable lifestyle.
One possible solution — especially for retirees in the middle tax brackets — is to consider higher-quality, shorter-term tax-free bond funds. This way, instead of renewing what are often one- or two-year CDs every year for the rest of their life, they may be able to get a much better after-tax income.

Sign up for Kiplinger’s Free E-Newsletters
Profit and prosper with the best of expert advice on investing, taxes, retirement, personal finance and more - straight to your e-mail.
Profit and prosper with the best of expert advice - straight to your e-mail.
How Risky Are Municipal Bonds?
Municipal bonds — or munis for short — provide a way that states or municipalities can borrow the funds they need to finance a public works project, and the interest they pay to investors who buy into them is exempt from federal taxes. Owners may owe a little in state taxes if the fund owns bonds issued outside their home state, but the same state income tax is always owed on the CD interest, so this would not eliminate the munis’ advantage over CDs.
The first thing to understand about tax-free municipal bonds is that unlike the money in the bank, they fluctuate and tend to move in the opposite direction of interest rates. Also, they are not FDIC insured.
How Can You Reduce That Risk?
However, there are strategies to reduce the overall risk enough so that some retirees may feel comfortable with them, and end up likely enjoying higher income. The way to reduce fluctuation in a municipal bond fund is to make sure that the average maturity of the bonds inside the fund is reasonably short. For example, Vanguard Intermediate Term Tax Exempt Fund Admiral (VWIUX) has an effective maturity of 5.3 years. Such short maturities tend to keep the fluctuation of the share price of the bond fund very modest most of the time.
To illustrate, if we go back the last 10 years this fund had one negative year, where it was down less than 1.5%. All the other years it had a positive return and a 10-year average annual total return of 3.88%. And, unlike with CDs, the interest it generated was tax free. Also, while the fund itself does not have a specific maturity date, the mutual fund shares are liquid, so the retiree can sell them on any business day at the fair market value.
To address the default risk (the risk that the state or municipality fails to pay on schedule), make sure you buy a fund where you are diversified over several hundred bonds being selected and watched by an experienced money manager. Also, be sure that the average credit quality of the bonds in the fund is AAA, AA, and A by Standard & Poor’s or Moody’s, since this means they will have an extremely low chance of default.
This same Vanguard fund mentioned above has over 9,000 bonds in it, so even if one defaulted, on average it would represent a minuscule part of the retiree’s money. And over 90% of these bonds are AAA, AA, or A rated.
How Do Tax-Free Muni Returns Compare to Taxable CDs?
The big plus of a shorter-term tax-free municipal bond fund is as an alternative to a retiree looking for higher income than a bank CD, but with less risk than being in something as risky as stocks.
To illustrate let’s assume a retiree has been buying shorter-term CDs averaging 1.5% and renewing them every year or two over the last several years. This would mean for every $100,000 sitting in the bank, they're averaging $1,500 in taxable interest per year. If the retiree is in a 24% tax bracket, he or she will give up 24% of this $1,500 in federal taxes, which would be $360, leaving the investor with $1,140 in after-tax interest.
Compare this to taking the same $100,000 and putting it in a short-term, high-quality tax-free bond fund like the Vanguard Intermediate Term Tax Exempt Fund mentioned above, which recently had a yield of 2.7%.
This means on $100,000 the investor would make $2,700 and it’s all federal tax-free. On an after-tax basis instead of earning $1,140, the retiree earned $2,700 picking up an extra $1,560.
While all the pros and cons should be weighed, including the risk, for retirees with a slightly higher risk tolerance, this may be a way to pick up more retirement income.

-
As Cable Companies Move into Mobile, Customers Benefit: The Kiplinger Letter
The Kiplinger Letter The new cable bundle — home internet and mobile — is gaining steam. And the competition means good news for consumers.
By John Miley Published
-
BNPL Sector Faces Financial and Regulatory Challenges
The Kiplinger Letter BNPL companies are facing the challenges of high costs, tightening financial conditions and regulatory scrutiny.
By Rodrigo Sermeño Published
-
How to Measure the Health of Your Retirement Plan
These five key indicators can help you make decisions based on the overall performance of your retirement plan rather than individual variables.
By Brian Skrobonja, Chartered Financial Consultant (ChFC®) Published
-
Four Easy Ways to Get Yourself Fired
Being a standout on the job can sometimes be as simple as showing up to meetings on time, responding promptly to requests, doing your homework and not being a jerk.
By H. Dennis Beaver, Esq. Published
-
How Might the Great Wealth Transfer Change Society?
As $84 trillion in assets move from Baby Boomers to younger generations, we could see a greater emphasis on financial technology and investing based on values.
By Jennifer Wines, JD, CPWA® Published
-
Why More Retirees Might Come Out of Retirement
It’s often not solely because of financial reasons, but because of a lack of purpose in retirement. This financial expert can relate.
By Chris Blunt Published
-
What Would Accreditation Change Mean for Real Estate Investors?
Investors determined by a test to be ‘financially savvy’ would be allowed to invest in ways that they can’t now without having a certain level of assets.
By Edward E. Fernandez Published
-
Five Simple Year-End Tax Tips to Set Up a Successful 2024
If you wait until the new year, you may miss out on some valuable tax planning strategies. Here’s what you need to know before closing out 2023.
By Julie Virta, CFP®, CFA, CTFA Published
-
Six Estate Planning Tips for Younger Generations
Millennials and Gen Zers are taking their estate planning seriously. These tips can help make the process seem less daunting.
By David Weinstock, CFP®, AEP®, CPA Published
-
Year-End Tax Planning for a Financially Healthier Retirement
Getting your tax ducks in a row for the end of the year can decrease your tax liability and make the most of your income, now and in retirement.
By Ryan Marston, Investment Adviser Representative Published