Inflation-protected government bonds (TIPS) can be a good choice for an IRA account. The face value of a TIP rises in connection with inflation, so investors can achieve a positive real return (after inflation). Investing municipal bonds in an IRA doesn’t make much sense. The big advantage of municipal bonds is their tax advantage.
The interest that these bonds pay is exempt from federal tax. If you opt for a municipal bond issued by your state of residence, interest is also exempt from government taxes. However, interest paid on investments within an IRA is already tax-free, so adding a municipal bond to an IRA negates its benefits. And since municipal bonds typically pay lower interest rates than non-tax-exempt bonds, you’re missing out on some of the interest you could get with another type of bond. Government bonds, sometimes called T-bonds, are debt instruments issued by the United States government.
When you buy a government bond, you’re essentially lending money to the government. In return, the government agrees to pay you interest twice a year over the life of the bond. As soon as the bond is due, the government will pay you back the money you lent it. It doesn’t make sense to include a tax-managed mutual fund in an IRA for the same reason municipal bonds are a bad IRA investment.
If you want to finance your retirement by selling the contents of your wine cellar, you’ll need to do so outside of your IRA. Another option for investors with higher risk tolerance is corporate bonds, which are issued by a company and are backed by the company’s ability to meet its liabilities. And because dividends are taxable, this can result in a heavy tax burden. However, adding the REIT to your IRA completely cancels out this particular drawback by protecting those dividends from taxes. Backed by the full confidence and credit rating of the United States government, government bonds are one of the safest investments you can buy.
