The Upside of the Trump Tax Plan: Private Activity Bonds
Millennial investors stand to gain from sheltering disposable income in bonds now that state and local taxes are no longer deductible from federal tax returns under the recently revised tax code.
The Tax Cuts and Jobs Act of 2017, signed by President Donald Trump and passed by Congress last December, is expected to boost economic growth by reducing tax rates and simplifying the tax code. It also retains tax-exempt status for private activity bonds (PABs).
“Initially poised to lose their tax-exempt status, PABs make up a lot of the high-yield market and comprise 30 percent of the overall muni market,” says Adam Weigold, vice president of Eaton Vance Management and senior portfolio manager on Eaton Vance’s municipal bond team.
How Private Activity Bonds Benefit the Trump Administration
Private activity bonds are a type of municipal bond. They’re particularly attractive now because they will potentially be used to finance President Trump’s proposed $1 trillion infrastructure plan.
During the 2016 campaign, Trump first promised to improve the condition of the nation’s roads, bridges, airports, and other public works. “The Trump administration may be interested in enhancing the ability to issue private activity bonds if they want an infrastructure bill to be successful,” Weigold says.
How Private Activity Bonds Benefit Investors
Although millennials will want to invest in stocks, which provide the longest-term growth potential, bonds can be used to diversify and balance a portfolio.
“If there are shorter-term goals, such as a home down payment or a super emergency fund, then bonds have a place,” says Jakob Loescher, a certified financial planner for Savant Capital Management in Rockford, Illinois.
Since 1926, the average annual return for large capitalization common stocks is 10.2 percent, according to the Ibbotson Yearbook. Government and corporate bonds return six percent, while cash is three percent. The same study shows that the volatility of equities is much higher than that of bonds.
“When it comes to building wealth, one can either sleep well or eat well,” says Robert R. Johnson, president and CEO of the American College of Financial Services.
“Investing conservatively allows one to sleep well, as there isn’t much volatility.”
Although bonds are considered a conservative investment, it’s their redemption that keeps investors coming back upon maturity. Plus, a higher level of maturities among bonds is expected this year. This will create the opportunity for an unexpected windfall that previously wasn’t liquid for those already invested.
“Overall, this is a net positive for the muni market,” Weigold says. “And the supply-demand ratio will benefit total return investors.”
He predicts that July will see the largest month of maturities that the municipal market has ever seen in any one month due to the sheer volume of bonds that were issued in 2008.