The allocation of investments in one’s portfolio changes over time. The young for example, can best afford to “risk big to win big,” and may not need to worry about tomorrow as much as later on in life. If you are turning the road towards retirement and are earning a handsome income—as many do at this point in their careers —you may want to rethink your strategy concerning your investment in municipal bonds (or “munis”). As you probably know, the interest generated from municipal bonds is tax-free on the federal level. Munis are some- times also exempt from state taxes, for example, if you purchase them from your state of domicile or from municipalities within your state.

Although their tax-exempt status normally makes munis attractive, they may become less so as you age — the savings from being exempt from federal taxation is most valuable when you are in a high tax bracket (that is, while you are working). However, the interest you earn on munis may be subject to the alternative minimum tax (AMT). You may also owe capital gains tax if you sell your munis at a profit.

Social Security and muni income may not mix well
Workers approaching retirement age must consider another issue: Contrary to popular belief, some portion of many people’s Social Security benefits is subject to income tax, and the attractiveness of holding munis may decline when you consider how deeply your Social Security benefits may be taxed. Although not widely discussed, Social Security benefits have been partially exposed to taxation since 1984.

Whether your Social Security is taxed depends on your “provisional income,” which is directly affected by whether you hold municipal bonds. Provisional income is calculated using (1) your adjusted gross income, (2) 50% of your yearly Social Security benefits, and (3) tax-exempt interest income from municipal bonds and/or municipal bond funds. Thus, your tax- exempt income is added to your taxable income when determining whether your Social Security benefits will be taxed.

You can receive up to $25,000 of tax-free Social Security benefits for a single taxpayer, or up to $32,000 for joint returns. A certain percentage of your Social Security benefits are taxed when your provisional income exceeds these limits: Up to 50% of your benefits are taxed until your income calculation exceeds $34,000 for a single filer or $44,000 on a joint return, at which point up to 85% of your Social Security benefits can be taxed. As your provisional income increases, the portion of your Social Security benefits that are exposed to taxation also rises.

Because many retirees fall into a lower tax bracket once they are no longer working, full-time or otherwise, holding munis becomes even less valuable to their overall investment strategies. If you find yourself in a lower tax bracket, you may want to alter your strategy to include investments in Treasury or corporate bonds—the latter of which often provides you with higher yields- the former is considered a safe investment.

You should also carefully evaluate how much your munis can offer after you take the potential for additional taxes into account, particularly if you are looking forward to retiring soon and collecting Social Security. If having munis results in your Social Security benefits getting taxed, you definitely need to rethink your overall strategy