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Tax exempts for savings

Question: I'm 58 and hope to partially retire in about 3 years and work part time as an ICU physician until I'm 66 at which time I'll draw a pension, take social security and tap our IRA. My wife and I have about $65k in savings that we keep trying to add to. It's our emergency fund and hopefully cover our initial living expenses when we fully retire. I'm toying with the idea of putting some of the money into a tax free municipal bond fund to get a little higher rate of return. This isn't money we want to risk and want to be able to access it when we need it. Is this a good idea or should we just leave it be? Brad, Farmington Hills, MI

Answer: I was just in Moorhead, Minnesota giving a talk about the state of the economy. Afterwards, I was talking to a broker and he mentioned that he had been buying for his own portfolio high grade municipal bonds since the yields are so attractive.

Of course, this morning's employment report shows the risk of this strategy. The job losses were concentrated among state and local governments. It's a troubled sector with governments around the country struggling to deal with yawning budget deficits. Although state government defaults are extremely rare, the bigger risk is credit downgrades by the rating agencies. Some localities have declared bankruptcy and more will do so.

Question: I'm 58 and hope to partially retire in about 3 years and work part time as an ICU physician until I'm 66 at which time I'll draw a pension, take social security and tap our IRA. My wife and I have about $65k in savings that we keep trying to add to. It's our emergency fund and hopefully cover our initial living expenses when we fully retire. I'm toying with the idea of putting some of the money into a tax free municipal bond fund to get a little higher rate of return. This isn't money we want to risk and want to be able to access it when we need it. Is this a good idea or should we just leave it be? Brad, Farmington Hills, MI

Anyone interested in buying tax-exempt securities should seek out a measure of financial safety by sticking with high quality general obligation bonds backed by government taxing power. With so-called revenue bonds--issues backed by fees--I'd stick with the debts of essential services, such as such as water and sewer treatment facilities. You'll give up some yield buying a diversified portfolio stocked with bonds from outside your state. But the portfolio will also offer an additional layer of financial safety. Diversification pays.

Municipal bonds are an intriguing investment. Yet it's a risky one, too. I would steer clear of tax-exempts since you say "this isn't money we want to risk." You want this money available to you when you need it. That means putting money into low-yielding--okay, very low yielding--safe securities like an online savings account and U.S. Treasury bills.

About the author

Chris Farrell is the economics editor of Marketplace Money.
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