Municipal bonds (or munis) have long anchored fixed income allocations for U.S. taxable investors. For investors in higher tax brackets, they are often used as part of portfolio planning and may offer potential after‑tax income benefits across market cycles.
These tax-efficient bonds don’t often grab headlines, yet some recent developments might make them a compelling investment choice: Evolving tax policies, particularly in high‑tax states, can make their after-tax yields more appealing, while elevated issuance by cities and states would provide more opportunities to buy these bonds when yields are higher.
We’ll discuss what these securities can add to your portfolio.
Income from municipal bonds isn’t subject to federal income taxes, and in many cases, it isn’t subject to state income taxes either. This means it can provide tax‑efficient yields for investors while financing essential infrastructure such as schools, transportation, hospitals and utilities.
Muni bonds typically have lower nominal or pretax yields when compared to riskier high yielding non-municipal bonds, which masks their appeal: From an investor’s standpoint, after‑tax yields matter most, which means munis continue to look compelling for tax-paying investors.
Today, if you are an investor in a top tax bracket (and depending on state and local tax rates), a 4% tax-free municipal bond yield can deliver the same amount of income as a taxable bond that yields approximately 6.75%. This can make a significant difference for you as a high income investor.
State taxes further widen the gap between pre‑ and after‑tax bond returns. California and New York have top marginal rates above 10%, amplifying the tax burden for residents. New York, Virginia, Rhode Island and Michigan have all increased taxes, and Washington passed legislation to impose a personal income tax on high earners. We believe this trend will continue.
This makes municipal bonds more attractive. Interest on these bonds remains exempt from federal income tax, and unlike most other investment income, it is also exempt from the 3.8% Medicare surtax on net investment income (or NIIT)1 .Furthermore, if you purchase bonds that are issued by the state you reside in, in most cases you do not have to pay state and local taxes on that income.
The taxable-equivalent yield (TEY) framework illustrates the tax advantages of muni bonds. It compares taxable bonds to tax-free municipal bond, showing how much additional nominal yield an investor would need to match the after-tax income a muni bond can potentially deliver.2 This table shows the results are striking:
This shows that a top bracket investor residing in New York City would need to find a 8.28% taxable bond to get the same after-tax yield as a 4.00% tax-free municipal bond. An investor in California would need an 8.00% taxable yield to achieve that same amount of after-tax income.
If state taxes on top earners continue to rise, the advantages of muni bonds could be that much more significant.
While the tax advantage alone would be compelling, the current credit environment provides additional comfort. Municipal credit quality has been on a sustained upswing:
In early 2025, the muni market was rattled by legislative uncertainty as investors wondered if the One Big Beautiful Bill Act would eliminate tax breaks that help make municipal bonds attractive. Many issuers rushed to sell bonds before any possible changes, creating a temporary supply glut. In the end, lawmakers left the tax exemptions in place, putting the muni market on firmer footing in 2026.
While the State and Local Tax (SALT) deduction cap was raised to $40,000, many high‑income earners continue to face state and local tax liabilities well above this level. As a result, effective marginal tax rates on investment income remain elevated, reinforcing the role of municipal bonds as an efficient tool for managing after‑tax income.
Seasonality is also a notable consideration in the municipal bond market, as periods of increased supply or reduced demand creating opportunities for investors. Taking advantage of these seasonal dynamics can allow you to lock in attractive tax‑efficient yields ahead of stronger reinvestment demand later in the year.
The after-tax case for municipal bonds varies more than most investors expect. It hinges on where you live, what you earn and how the rest of your portfolio is positioned. A closer look at the specifics of your situation can reveal whether it makes sense to give munis a larger role.
To learn more, reach out to your team to help you assess whether an additional allocation to municipal bonds could make sense for your portfolios.
We can help you navigate a complex financial landscape. Reach out today to learn how.
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