If you have $5 million in cash, you can buy a bunch of munis for your state, and get, even now, a 4% return on your investment. That's miserable, but that's still about $200,000 a year -- and you owe no income tax on it. I think, with a little restraint, it is possible to live pretty decently on that. :-)
Of course, in exchange for the low interest rate, munis are traditionally considered pretty safe. But this article from the August 15, 2012 Washington Post, would indicate that they aren't quite as safe as everyone assumes:
Defaults on municipal bonds for decades have been far higher than reported by rating agencies, bringing into question the true risk of a common investment widely considered to be safe, according to a study released Wednesday by the Federal Reserve Bank of New York.
Economists at the agency counted 2,521 muni bond defaults since 1970, whereas ratings agency Moody’s Investors Service, for instance, reported 71....
Supporters of muni bonds say that despite a few high-profile cases, government securities rarely default. Data from the New York Fed, however, suggests otherwise.
What is important is that the study found that general-obligation bonds, "rarely fail because they are backed by tax revenue." The bonds that are used to finance various specific projects, and where the repayment of the bond is dependent on a particular facility such as a hospital or stadium, have higher default rates. The high risk turns out to be "industrial development" bonds, and these "fail at a 28 percent rate." UPDATE: A commenter at the Washington Post reports that the Fed study actually says that 28% of the defaulted bonds are industrial development munis. That is a lot more plausible than a 28% default rate.
I have always been a bit skeptical about munis because I worried about default risk. This gives me increased confidence, however, that general-obligation munis are pretty safe--and the risk is all the others.