How a $500,000 Position in This Schwab Muni ETF Pays a Married Couple in the 32% Bracket an Extra $6,500 a Year in After Tax Income

In 2021, Elon Musk paid over $11 billion to the IRS (his 2026 federal tax may be significantly larger, due to the SpaceX IPO). The top bracket is 37%, with an additional 3.8% Net Investment Income Tax (NIIT) for high earning citizens, resulting in a tidal 40.8%. While most working people are not at Musk’s income level, that means high net worth and high earning Americans only get to keep 59.2% of their income (above $751,600 for couples, or $626,350 if single) before factoring in state and city taxes, if applicable. 

Municipal bonds pay tax-free income that requires some math calculation to fully appreciate the advantages they offer to HNW investors. For example, a $500,000 municipal bond or muni ETF investment that pays a 3.5% coupon equates to $17,500, tax-free. An equivalent amount in taxable bonds or bond ETFs that pay at the 32% bracket and an additional 5% state tax nets out to $11,025 after subtracting the $6,475 cumulative tax bite. 

Most couples could certainly use an additional $6,475 for anything like new furniture or a vacation to NBA championship finals tickets. Rare is the couple that would prefer that the government take that money. 

For couples who want municipal bond exposure without having to maintain a portfolio of separate bonds, the Schwab Municipal Bond ETF (NYSE: SCMB) may very well fit the bill. It can provide a varied bond mix to mitigate diversification risk, and monitors any calls, maturity redemptions, and all of the other responsibilities that bond investors need to properly manage a portfolio – all in a single ETF. 

Schwab Municipal Bond ETF

Schwab’s SCMB ETF only made its debut in 2022, but it already has captured an impressive investor base and AUM in that short time.

Despite Schwab’s long history in creating funds for retail investors, it surprisingly waited until 2022 to launch SCMB, its first and only municipal bond ETF. Prior to then, it only offered municipal bond mutual funds, which started 30 years earlier, in 1992. The high interest rates of 2021-2022, was the primary incentive for Schwab to debut its own municipal bond ETF. By charging a very low 0.03% expense ratio, it was designed to lure investors away from Vanguard and other rivals. SCMB tracks the ICE AMT-Free Core U.S. National Municipal Index. Investor enthusiasm has been strong; SCMB underwent a 2-for-1 forward split on October 10, 2024. Other details include:

Top Holdings:

• Massachusetts St. G.O.: 0.23%
• Gwinnett County GA School District: 0.23%
• Pennsylvania State G.O.: 0.22%
• New York City G.O.: 0.21%
• California State Dept. of Water Resources: 0.20%

Municipal Bond ETF Investments Not The Same and Not For Everybody

The tax free income from SCMB requires retirees to calculate tax differentials so that the IRS doesn’t penalize them by exceeding MAGI thressholds that could unexpectedly hike Medicare premiums and lower Social Security benefits.

The tax advantages of municipal bonds are best enjoyed by those in the top tax brackets, since they get the biggest tax benefit. Nevertheless, there are certain specific areas where SCMB may be more appealing, and others where it might not. For example”

• If one is specifically looking for federal tax savings, SCMB’s 3.55% yield and 0.03% expense ratio is more attractive than its rivals, such as iShares National Muni Bond ETF (NYSE: MUB), which has a 3.40% yield and a 0.05% expense ratio, and Vanguard Tax-Exempt Bond ETF (NYSE: VTEB), yield of which is 3.55% and expense ratio of 0.03%. 
• Not all muni bond ETFs are free of Alternative Minimum Tax, so if that feature is important, then an ETF with specifically not AMT munis, then SCMB, MUB and VTEB all fit the bill. 
• Municipal bond income can have an unintended boost effect on IRS projections in calculating one’s Modified Adjusted Gross Income (MAGI). As such, this can impact retirees’ Social Security benefits, Medicare B and D premiums, and other programs millions of seniors depend on. 
• Investors living in triple-tax states like NY or CA where local taxes are also assessed will prefer a state-specific muni bond ETF, since out-of-state bond incomes (except Puerto Rico and Guam) are taxed like corporate bonds.
• Liquidity Risks – most municipal bonds’ primary buyers are in their state of issuance, so their pool of buyers and sellers is narrower than with corporate bonds. 
• Call Risk – unlike corporate bonds, a number of municipal bond issues have call provisions and fixed call protection periods. When bonds are called, they are redeemed at the projected call price for that year and proceeds need to be reinvested.  
• Municipal Bonds are subject to political risk, in the sense that local governments that vote in leaders who mismanage funds and resources can cause a default situation of a credit rating drop. New York City’s rating, for example, has been downgraded to “negative” and is on the brink of a rating downgrade, thanks to the overbloated budget and tax hike proposals from Leftist Mayor Mandani.