Municipal bonds are one way to obtain income that is generally not taxable, but income expert Richard Lehmann has other approaches that he thinks are better.

My guest today is Richard Lehmann, and we’re talking about tax-sheltered income. Hi, Richard, thanks for joining me.

Thank you, Nancy.

So where do people really go to get the best tax-sheltered income today?

There are multiple sources for it. The traditional one was municipal bonds. The fact of the matter is that the yields on municipal bonds now are at ridiculous levels.

Do we still have to worry about their credit worthiness today?

I don’t think the credit worthiness is as much of a concern as the fact that you have huge interest rate risk, because when you’re getting 2% tax free, it’s still only 2%. That’s an artificially low rate.

The point is that municipal bonds are not very liquid. Consequently, if rates start to change, they change in a hurry, and being in an illiquid asset is not the answer.

The place that I feel is best for individual investors...there are a couple of things. One is the tax agreement that was reached at the end of the year, where Congress now has differentiated the taxation of dividends and interest in a significantly different way.

The maximum tax on interest income is as much as 39.5%. On dividends, the maximum is 20%, and if you earn below $450,000 it’s 15%, and if you earn below $15,000 it’s zero. Obviously, there is a significant preference for dividend income over interest income.

Another good source is master limited partnerships, which is still one of the last refuges for tax-deferred income. They are like the pipeline companies in the United States. Because of the fact that we now see that the US is on the road of becoming energy self-sufficient, which is a very unusual development, it means the pipeline companies that are the carriers are going to be the biggest beneficiaries here.

The refineries are located near the coast where ships can bring the oil to them, and that was a way of getting the oil to the refinery. Now if it’s domestic sourcing, it’s going to be the pipelines that are going to be bringing that oil to the refineries.

Richard, are there any MLP pipeline companies that you particularly like today?

Yes, there are several of them, but one of the largest is Plains American Pipeline (PAA). They are one of the biggest, and they have a very good infrastructure for gas and oil. As I said, the sourcing of oil refineries is going to be from domestic, so these pipeline companies stand to have significant improvements in their volume.

Plains has already a stellar track record for growing dividends, so this is just going to give you some capital appreciation on top of a very good tax-sheltered income.

What is their yield?

Right now, it’s about 5.6%.

That’s pretty healthy in today’s low-interest-rate environment.

Especially-tax sheltered, yes.

Yeah, what’s tax-sheltered, but then at the end when you sell those, do you have a recapture tax with the pipelines or not?

When you sell it...what happens is that you collect these dividends and you reduce your cost basis. Therefore, when you sell it you have a capital gain. Again, it’s a long-term capital gain.

In the meantime, you’ve been collecting all those healthy dividends.

You get a tax-free dividend. And then if you sell in the right tax year, you’ll only pay like 15% or 20% tax.

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