Blue Light Special: State-Tax Free Government Agency Securities

John Robinson |

Blue Light Special:  State Tax-Free Government Agency Securities

By John H. Robinson, Financial Planner (September 4, 2023)

It is so, so nice that people can once again earn interest on their savings.  With yields north of 5% on CDs and Treasuries there does not seem to be any great reason to take on credit risk to each out higher yields.  Although the current yields are by no means high by historical standards, they are the highest they have been in more than twenty years.  This is the first time in a full generation than investors have seen yields high enough to generate meaningful  income for retirement spending.

For the time being, I am perfectly content to help client feast on current yields and build laddered CD and Treasury portfolios.  We are encouraging clients not to leave 0% cash sitting around for long and even have encouraged some client to reduce equity allocations. 

3 Agencies You Should Know

At the same time, I would be remiss if I did not at least mention in passing that certain government agency securities – specifically bonds issued by the Federal Home Loan Bank, Federal Farm Credit Bureau, and Tennessee Valley Authority may merit consideration as well.  All three of these agencies pay interest that is exempt from state income tax.  This makes them particularly attractive in states with high personal income tax rates, such as Hawaii, New York, Massachusetts, and California.

Additionally, the reason I am writing this post is that yields to maturity at the 5 year level for new issued bonds are now around 6%.  6%, state tax free, and implicit backing of the federal government is enough to get my attention.  What’s more is that some of these bonds pay interest monthly, which is always a convenient feature in income portfolios.


What’s the Catch? – Call Risk

6%, state tax free, with little credit risk should attract investors like a moth to a flame.  The problem with these bonds is that most are almost immediately callable, meaning that if interest rates fall, the issuing agencies can refinance these bonds at lower rates by calling them in at par.

Novice investors might not care.  In fact, I frequently encounter consumers who regard call features a beneficial saying that they prefer not to have their money tied up for 5 years anyway.  On this score, let me be perfectly clear.  Call features are never a benefit.  Bonds with call features will likely only be called when it is in the issuer’s financial interest to do so.  The bonds will only last to maturity in environments in which the bond holders wish they would be called.

Nonetheless, I do believe agency securities may be appropriate at this time for inclusion as a portion of some clients’ bond portfolios.  My best advice to investors who find these bonds attractive is to expect the bonds to be called, but be prepared to hold to maturity and be happy with your 6%, even if rates are higher.

For additional information, here is a link to a good plain English Schwab article on agency securities - U.S. Agency Bonds: What you should know (Charles Schwab)

John H. Robinson is the owner/founder of Financial Planning HawaiiFee-Only Planning Hawaii, and Paraplanning Hawaii.  He is also a co-founder of fintech software-maker Nest Egg Guru.