Tax-Exempt Bond Fund (Municipal Bonds)

What is a tax-exempt bond fund?

A tax-exempt bond fund (sometimes known as a municipal bond fund or muni bond fund) invests in tax-exempt municipal debt instruments issued by state governments or agencies, counties, cities, towns, or other political districts. From the shareholder's point of view, the key feature associated with these funds is the advantageous income tax treatment they receive. This income tax treatment is generally the same as that enjoyed by holders of individual municipal bonds. Just as interest paid by municipal bonds is generally tax exempt at the federal level, so the income generated by municipal bond funds will also be free from federal income taxation.

Further, as with income produced by municipal bonds, the dividends paid by these funds may be exempt from state and local taxes as well. The dividends you received from a tax-exempt bond fund would likely avoid state income tax only in proportion to the percentage of total fund income attributable to securities issued in your home state. Any portion of income earned by securities issued outside your home state might be subject to state taxation.

The tax advantage means that, depending on your tax bracket, the after-tax return from a tax-exempt bond fund could actually be higher than that of a taxable bond fund.

Caution:  Keep in mind that while dividends derived from income may be tax exempt, dividends derived from capital gains are not.

Caution:  If you are subject to the alternative minimum tax (AMT), you must include interest income from certain municipal securities in calculating the tax unless the securities are specifically exempted from the AMT. For example, the American Recovery and Reinvestment Act of 2009 specifically exempts interest on private activity bonds issued in 2009 and 2010 from being included in AMT calculations.

What is a state tax-exempt bond fund?

As noted above, any state income tax advantage applies only to income from bonds issued in the taxpayer's home state or local municipality. However, some tax-exempt bond funds, known as state tax-exempt bond funds or single-state muni bond funds, invest exclusively in debt instruments issued by a particular state. A California tax-exempt bond fund, for instance, holds only bonds issued by or within the state of California. For residents of the state that issues the bonds--in this case, California--income from the fund is free from both federal and state income tax; residents of other states receive the federal but not the state tax benefit.

If you live in a local municipality (for example, a city or town) that levies its own taxes, a portion of your fund income may avoid those taxes as well if some of the bonds held by the fund were issued directly by your municipality.

Tip:  There are state tax-exempt bond funds for almost every state in the United States.

When can it be used?

Tax-exempt bond funds may be suitable for somewhat conservative investors who want to invest in mutual funds without the volatility that may accompany stock funds and certain corporate bond funds. They are appropriate for investors seeking current income and for individuals in high tax brackets who want to minimize their income tax liability. Investors with more modest levels of income may not benefit as much from the tax treatment, however. The income they provide also can be used to help moderate volatility from other investments in a portfolio.

Strengths
Income tax benefits

The tax advantages are the greatest strength of tax-exempt municipal bond funds. Not only is the income generated by these funds free from federal taxation, but it may avoid state and local taxation in some cases as well. Investors may even enjoy triple tax-exempt treatment. This might occur, for instance, in the case of a New York City resident who would avoid federal, state, and city taxes on the portion of fund dividends representing income earned by New York City bonds. If you pick the right fund, these tax savings can significantly reduce your total tax bill. In general, the higher your tax bracket, the more attractive the tax benefits become.

Provides current income

Most bond funds seek to provide current income. However, these funds may provide a more reliable source of current income than most other bond funds. Even if you don't need the extra income, you can still reinvest your dividends, or simply allow the income to help moderate the volatility of your portfolio

May carry lower risk than some other bond funds

Though it's not impossible for state and local governments to default on bonds, the default rate on munis historically has been lower than that for corporate bonds (though past performance is no guarantee of what might happen in the future, of course). Because governments are generally able to raise taxes if necessary to pay their debts, muni bonds as a whole are considered a relatively conservative bond choice. And by investing in debt from a variety of issuers, a bond fund reduces the impact of possible default by a single governmental body.

Tradeoffs
Generally modest returns

The return on a given tax-exempt bond fund depends on several variables that affect municipal bond yields, including local economic factors and quality ratings assigned to specific securities. Because of their tax advantage, returns are generally expected to be lower than with other investments (though as noted above, the tax advantage also means that depending on an investor's tax bracket, the net return could actually be higher than that of a taxable bond fund).

Susceptible to interest rate risk and inflation risk

When interest rates rise, bond prices fall. When interest rates go down, bond prices rise. Shares in a bond fund that you may have bought when interest rates were low can lose value as interest rates increase because the existing bonds in the portfolio aren't as valuable as newer bonds that pay higher interest rates. (However, one advantage of having a bond fund is that the fund's manager also can adjust the portfolio over time to take advantage of those higher-paying bonds.)

Inflation risk refers to the possibility that the return on your investments won't keep pace with increasing price levels. As prices rise, the value of a dollar falls, resulting in a decreased ability to purchase goods and services. Bonds that offer a fixed interest rate assume this kind of risk. If the overall interest paid by the bonds in your fund is lower than the inflation rate, your investment dollars may not grow enough over the years to allow you to reach your financial goals. And if you rely on the fund for current income, those payments may lose purchasing power to inflation over time.

As with all bond funds, both tax-exempt and state tax-exempt bond funds never mature as an individual bond does. Therefore, they don't offer the same assurance that your principal will be returned to you at some fixed future date. Before investing, carefully consider a fund's investment objectives, risks, fees, and expenses, which can be found in the prospectus available from the fund. Read it carefully before investing, as you would with any mutual fund.

State tax-exempt funds offer less diversification

The trade-off for receiving a greater tax advantage from a single-state muni fund focused on your state is the greater risk involved in a more narrowly focused fund. Because the fund's holdings are limited to the bonds of one state, it has less protection from the impact of local economic problems. For example, if a state is heavily dependent on an industry that experiences an economic downturn, its finances (and those of the cities and towns in it) could be at greater risk of struggling to meet debt payments. If your job might also be affected by the same circumstances, that would put you doubly at risk.

Also, some states may have legal requirements that make it more difficult for a governmental body to raise taxes, even to pay its debts. Though diversification alone can't guarantee a profit or ensure against a loss, municipal funds that invest in bonds issued by multiple states may offer greater diversification and more diluted risk.

6 RISKS TO A SECURE RETIREMENT

You have dreams for retirement. But you need to understand six common risks most retirees face and take steps to protect your retirement dreams from these risks:

1. Health care expenses. Medical costs have risen at more than twice the rate of overall inflation in recent
decades.1 That trend is especially problematic for retirees, who on average spend a greater percentage of their income on health care costs. The Employee Benefit Research Institute estimates that the average husband and wife who turned 65 in 2010 will need roughly $250,000 in savings to pay for health care expenses not covered by Medicare during their retirement.2 Imagine how high these costs could be when you retire.

2. Unexpected events. Unplanned developments in your life can have a major impact on your finances. Some may be personal: a lawsuit, a family member in need. Others may be external, such as changes to tax laws, Social Security or a pension. All of these events could force you to withdraw money from savings and perhaps even jeopardize your retirement accounts.

3. Market volatility. The growing interconnectedness of world economies and the ever-increasing speed of global capital flows have made the markets more volatile than ever. If you don’t have a sound investment plan coupled with an emergency cash strategy, a large drop in financial markets at home or abroad could reduce the value of your retirement accounts. Volatility can be particularly damaging to a portfolio during retirement when you’re withdrawing assets; selling long-term assets at depressed levels can reduce the value of your portfolio, forcing you to lower your income in retirement.

4. Longevity. The risk of outliving one’s assets is of great concern in a time of rising life expectancies and earlier retirements. The average 65-year-old man can expect to live more than 20 years, while the average 65-year-old woman is likely to live at least 23 years. And if you’re married, you have an excellent chance of living longer: A 65-year-old couple faces a 50% chance that one spouse will live past 92, and a 25% chance that one spouse will live to 97.3

5. Inflation. Some economists believe inflation is likely to climb in the years ahead. But even at low rates Inflation can deteriorate the buying power of your savings. In fact, 24 years from now, inflation will nearly double the cost of living for the typical consumer, based on the historical annual average of 3%.

6. Withdrawal rate. Pulling too much from savings early in retirement increases the risk that you could outlive your money. That’s because early withdrawals can leave you with a smaller asset base, which means less opportunity for growth over time. 

Each of these risks can build on the other, making it crucial to manage them all properly. For example, a
market downturn could reduce the value of your retirement accounts, increasing the risk that excessive withdrawals could exhaust your savings early.

By taking action today, you have the potential to make your retirement everything you’ve always dreamed of.
An Ameriprise financial advisor can help you construct a complete plan that includes solutions to address these risks while also helping you meet your financial objectives — all within the context of your individual situation and goals — so you can feel more confident about retirement.

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1Bureau of Labor Statistics, February 2011. Refers to period 1965–2010.
2 “Savings Needed for Health Expenses in Retirement: An Examination of Persons Ages 55 and 65 in 2009”, Employee Benefit Research Institute, June 2009.
3Annuity 2000 Mortality Table.

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FINANCIAL PLANNING - HELPING YOU SEE THE BIG PICTURE

Do you picture yourself owning a new home, starting a business, or retiring comfortably? These are a few of the financial goals that may be important to you, and each comes with a price tag attached.

That's where financial planning comes in. Financial planning is a process that can help you reach your goals by evaluating your whole financial picture, then outlining strategies that are tailored to your individual needs and available resources.

Why is financial planning important?

A comprehensive financial plan serves as a framework for organizing the pieces of your financial picture. With a financial plan in place, you'll be better able to focus on your goals and understand what it will take to reach them.

One of the main benefits of having a financial plan is that it can help you balance competing financial priorities. A financial plan will clearly show you how your financial goals are related--for example, how saving for your children's college education might impact your ability to save for retirement. Then you can use the information you've gleaned to decide how to prioritize your goals, implement specific strategies, and choose suitable products or services. Best of all, you'll have the peace of mind that comes from knowing that your financial life is on track.

The financial planning process

Creating and implementing a comprehensive financial plan generally involves working with financial professionals to:

• Develop a clear picture of your current financial situation by reviewing your income, assets, and liabilities, and evaluating your insurance coverage, your investment portfolio, your tax exposure, and your estate plan

• Establish and prioritize financial goals and time frames for achieving these goals

• Implement strategies that address your current financial weaknesses and build on your financial strengths

• Choose specific products and services that are tailored to meet your financial objectives

• Monitor your plan, making adjustments as your goals, time frames, or circumstances change

Some members of the team

The financial planning process can involve a number of professionals. 

• Financial planners typically play a central role in the process, focusing on your overall financial plan, and often coordinating the activities of other professionals who have expertise in specific areas.

• Accountants or tax attorneys provide advice on federal and state tax issues.

• Estate planning attorneys help you plan your estate and give advice on transferring and managing your assets before and after your death. 

• Insurance professionals evaluate insurance needs and recommend appropriate products and strategies. 

• Investment advisors provide advice about investment options and asset allocation, and can help you plan a strategy to manage your investment portfolio.

• The most important member of the team, however, is you. Your needs and objectives drive the team, and once you've carefully considered any recommendations, all decisions lie in your hands.

Why can't I do it myself?

You can, if you have enough time and knowledge, but developing a comprehensive financial plan may require expertise in several areas. A financial professional can give you objective information and help you weigh your alternatives, saving you time and ensuring that all angles of your financial picture are covered.

Staying on track

The financial planning process doesn't end once your initial plan has been created. Your plan should generally be reviewed at least once a year to make sure that it's up-to-date. It's also possible that you'll need to modify your plan due to changes in your personal circumstances or the economy. Here are some of the events that might trigger a review of your financial plan:

• Your goals or time horizons change

• You experience a life-changing event such as marriage, the birth of a child, health problems, or a job loss

• You have a specific or immediate financial planning need (e.g., drafting a will, managing a distribution from a  retirement account, paying long-term care expenses)

• Your income or expenses substantially increase or decrease

• Your portfolio hasn't performed as expected

• You're affected by changes to the economy or tax laws

Common questions about financial planning

What if I'm too busy?

Don't wait until you're in the midst of a financial crisis before beginning the planning process. The sooner you start, the more options you may have.

Is the financial planning process complicated?

Each financial plan is tailored to the needs of the individual, so how complicated the process will be depends on your individual circumstances. But no matter what type of help you need, a financial professional will work hard to make the process as easy as possible, and will gladly answer all of your questions.

What if my spouse and I disagree?

A financial professional is trained to listen to your concerns, identify any underlying issues, and help you find common ground.

Can I still control my own finances?

Financial planning professionals make recommendations, not decisions. You retain control over your finances. Recommendations will be based on your needs, values, goals, and time frames. You decide which recommendations to follow, then work with a financial professional to implement them.

ESTIMATING YOUR RETIREMENT INCOME NEEDS

You know how important it is to plan for your retirement, but where do you begin? One of your first steps should be to estimate how much income you'll need to fund your retirement.

That's not as easy as it sounds, because retirement planning is not an exact science. Your specific needs depend on your goals and many other factors.

Use your current income as a starting point

It's common to discuss desired annual retirement income as a percentage of your current income. Depending on who you're talking to, that percentage could be anywhere from 60 to 90 percent, or even more.

The appeal of this approach lies in its simplicity, and the fact that there's a fairly common-sense analysis underlying it: Your current income sustains your present lifestyle, so taking that income and reducing it by a specific percentage to reflect the fact that there will be certain expenses you'll no longer be liable for (e.g., payroll taxes) will, theoretically, allow you to sustain your current lifestyle.

The problem with this approach is that it doesn't account for your specific situation. If you intend to travel extensively in retirement, for example, you might easily need 100 percent (or more) of your current income to get by. It's fine to use a percentage of your current income as a benchmark, but it's worth going through all of your current expenses in detail, and really thinking about how those expenses will change over time as you transition into retirement.

Project your retirement expenses

Your annual income during retirement should be enough (or more than enough) to meet your retirement expenses. That's why estimating those expenses is a big piece of the retirement planning puzzle. But you may have a hard time identifying all of your expenses and projecting how much you'll be spending in each area, especially if retirement is still far off. To help you get started, here are some common retirement expenses:

• Food and clothing

• Housing: Rent or mortgage payments, property taxes, homeowners insurance, property upkeep and repairs

• Utilities: Gas, electric, water, telephone, cable TV

• Transportation: Car payments, auto insurance, gas, maintenance and repairs, public transportation

• Insurance: Medical, dental, life, disability, long-term care

• Health-care costs not covered by insurance: Deductibles, co-payments, prescription drugs

• Taxes: Federal and state income tax, capital gains tax

• Debts: Personal loans, business loans, credit card payments

• Education: Children's or grandchildren's college expenses

• Gifts: Charitable and personal

• Savings and investments: Contributions to IRAs, annuities, and other investment accounts

• Recreation: Travel, dining out, hobbies, leisure activities

• Care for yourself, your parents, or others: Costs for a nursing home, home health aide, or other type of assisted living

• Miscellaneous: Personal grooming, pets, club memberships

Don't forget that the cost of living will go up over time.

The average annual rate of inflation over the past 20 years has been approximately 3 percent. (Source: Consumer price index (CPI-U) data published annually by the U.S. Department of Labor, 2009.) And keep in mind that your retirement expenses may change from year to year. For example, you may pay off your home mortgage or your children's education early in retirement. Other expenses, such as health care and insurance, may increase as you age. To protect against these variables, build a comfortable cushion into your estimates (it's always best to be conservative). Finally, have a financial professional help you with your estimates to make sure they're as accurate and realistic as possible.

Decide when you'll retire

To determine your total retirement needs, you can't just estimate how much annual income you need. You also have to estimate how long you'll be retired. Why? The longer your retirement, the more years of income you'll need to fund it. The length of your retirement will depend partly on when you plan to retire. This important decision typically revolves around your personal goals and financial situation. For example, you may see yourself retiring at 50 to get the most out of your retirement. Maybe a booming stock market or a generous early retirement package will make that possible. Although it's great to have the flexibility to choose when you'll retire, it's important to remember that retiring at 50 will end up costing you a lot more than retiring at 65.

Estimate your life expectancy

The age at which you retire isn't the only factor that determines how long you'll be retired. The other important factor is your lifespan. We all hope to live to an old age, but a longer life means that you'll have even more years of retirement to fund. You may even run the risk of outliving your savings and other income sources. To guard against that risk, you'll need to estimate your life expectancy. You can use government statistics, life insurance tables, or a life expectancy calculator to get a reasonable estimate of how long you'll live. Experts base these estimates on your age, gender, race, health, lifestyle, occupation, and family history. But remember, these are just estimates. There's no way to predict how long you'll actually live, but with life expectancies on the rise, it's probably best to assume you'll live longer than you expect.

Identify your sources of retirement income

Once you have an idea of your retirement income needs, your next step is to assess how prepared you are to meet those needs. In other words, what sources of retirement income will be available to you? Your employer may offer a traditional pension that will pay you monthly benefits. In addition, you can likely count on Social Security to provide a portion of your retirement income. To get an estimate of your Social Security benefits, visit the Social Security Administration website (www.ssa.gov) and order a copy of your statement. Additional sources of retirement income may include a 401(k) or other retirement plan, IRAs, annuities, and other investments. The amount of income you receive from those sources will depend on the amount you invest, the rate of investment return, and other factors. Finally, if you plan to work during retirement, your job earnings will be another source of income.

Make up any income shortfall

If you're lucky, your expected income sources will be more than enough to fund even a lengthy retirement. But what if it looks like you'll come up short? Don't panic--there are probably steps that you can take to bridge the gap. A financial professional can help you figure out the best ways to do that, but here are a few suggestions:

• Try to cut current expenses so you'll have more money to save for retirement

• Shift your assets to investments that have the potential to substantially outpace inflation (but keep in mind that investments that offer higher potential returns may involve greater risk of loss)

• Lower your expectations for retirement so you won't need as much money (no beach house on the Riviera, for example)

• Work part-time during retirement for extra income

• Consider delaying your retirement for a few years (or longer)

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Brian White is a Financial Advisor and an Associate Vice President at Ameriprise Financial located in Melville. Brian has over seven years experience in the financial services industry and runs a successful financial planning practice.  Over his career as a Financial Advisor, Brian has achieved notable accomplishments that rank him among the top of his peers such as The Mercury Award, The First Year Top Achiever and The Circle of Success.   Brian is a member of the Advanced Advisor Group and has earned the Chartered Retirement Planning Counselor designation.  

Brian works with clients to design a personal financial plan based on their life goals. This strategy focuses on helping them become more confident about managing their financial objectives. It is designed to provide solutions to both the everyday and long-term financial questions and is personalized to meet the needs of high net worth individuals and small business owners. Brian and his staff continually monitor progress toward financial goals and update plans based on changes in market conditions and individual situations.  

Brian attended Adelphi University from 2000-2004 and graduated Cum Laude with a Bachelors Degree in Business Finance.

Contact:  631-574.2973 | Fax: 631.582.4243 | Mobile: 631.871.2560 | Brian.X.White@ampf.com

The information contained in this material is being provided for general education purposes and with the understanding that it is not intended to be used or interpreted as specific legal, tax or investment advice. It does not address or account for your individual investor circumstances. Investment decisions should always be made based on your specific financial needs and objectives, goals, time horizon and risk tolerance.

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Neither Ameriprise Financial Services, Inc. nor any of its employees or representatives are authorized to give legal or tax advice. You are encouraged to seek the guidance of your own personal legal or tax counsel. Ameriprise Financial Services, Inc. Member FINRA and SIPC.

The information in this document is provided by a third party and has been obtained from sources believed to be reliable, but accuracy and completeness cannot be guaranteed by Ameriprise Financial Services, Inc. While the publisher has been diligent in attempting to provide accurate information, the accuracy of the information cannot be guaranteed. Laws and regulations change frequently, and are subject to differing legal interpretations. Accordingly, neither the publisher nor any of its licensees or their distributees shall be liable for any loss or damage caused, or alleged to have been caused, by the use or reliance upon this service.