Municipal bonds comprise about 10% of the U.S. bond market. With an estimated $2 trillion in unfunded pension and healthcare obligations, munis should no longer be considered risk-free. Detroit may or may not be the beginning of a longer-term default trend.

But sometimes the choice can be made easier by locating assets in the right tax wrapper. Here’s an example:

Assume that a client comes to us with $100,000 in muni bonds in his taxable portfolio, and $100,000 in stocks or low-turnover stock funds in his IRA. Regarding asset location, owning stocks in an IRA is merely converting tax-advantaged dividend and long-term capital gains into eventual ordinary income. And because stocks generally appreciate more than bonds, this investor is doing more than his fair share to pay down the U.S. debt.

The obvious solution is to own the stocks in the taxable account and buy bonds in the IRA. So jettison the muni bonds in the taxable account and buy low- or no-turnover stock funds. Then sell the stocks in the IRA and buy taxable U.S. government bonds in their place. You’ve now both increased the client’s expected return and lowered potential default risk from owning the munis.

The implications of the math behind this logic is that advisors should never buy the municipal bond or bond fund while the client has tax advantaged equities in their IRAs. Of course if there is not enough room in the IRA to build the complete bond portfolio, then municipal bonds could very well make sense – at least in moderation. The same logic may not pan out for the client’s Roth IRA, but the math behind that is more specific to the clients’ particular situation.

Allan S. Roth, a Financial Planning contributing writer, is founder of the planning firm Wealth Logic in Colorado Springs, Colo. He also writes the Irrational Investor column for CBS MoneyWatch.com and is an adjunct instructor at the University of Denver.

Allan S. Roth

Allan S. Roth

Allan S. Roth, a Financial Planning contributing writer, is founder of the planning firm Wealth Logic in Colorado Springs, Colo. He also writes for AARP and has taught investing at three universities.