Tax-free Municipal Bonds

Tax Free Municipal Bonds
Written by Kurt White   
Most people think that buying municipal bonds , sometimes called munis, is a bit of a mystery. Municipal bonds are actually a dream for an investor. The income that is earned off of the interest that is paid is not subject to federal taxes , and in some cases, taxes from the state. They are not just a financial instrument. They actually help city and/or county governments be able to pay for some infrastructure in the form of roads or bridges. They even can help the governments pay for new schools and sewer maintenance.

There are a few things to consider when buying tax free municipal bonds.  You should search the Internet and research some of the following things:
  • You should be aware of a tax for a municipal bond that will apply to any interest that is earned and what costs will be involved in purchasing the municipal bonds such as transaction cost.
  • Research the issuer.  Also make sure you are aware of what the use the bond is for.
  • You will want to insure that you are being offered a fair price for the bond and checking the recent transaction prices can do this.
  • Make a point to find out if the municipal bond has been insured or not.
There is a lot of information that you should know before investing.  Currently, there are more than 2 million bond issues that some 50,000 local and state entities issue.  The estimate bonds that are traded daily are worth about $1 billion. That would put municipal bonds valued at more than $1.5 trillion in the investor’s hands.

Financial planners have different opinions on whether to purchase municipal bonds alone and individually or if investing in a municipal bond fund is better.  If you purchase individual bonds you will have the freedom to control your own portfolio.  Funds will offer diversity, inexpensive trading costs and liquidity.  A manager who has the knowledge of when to buy bonds that are somewhat lower in grade in order to get significant yields also runs them.  You might want to look at some firms that manage the funds.  Wells Fargo and Fidelity are two of the largest and well-known ones.  They have a lot of funds that will assist you when you are looking for tax free municipal bonds.

You might want to consider taking out insurance for your municipal bond.  This will guarantee that the holder will get the payment from interest even if the issuer of the bond defaults.  It lasts for the lifetime of the bond and the insurer cannot cancel it.  Typically, the municipal bonds that have a BBB or higher credit rating will be insured.  You can also take out a policy on municipal bond funds.

You will only want to buy a municipal bond that the municipality that issued it has more than 10,000 people, an economy that is diverse and has shown that it pays the payments on time.

When buying a municipal bond you are loaning money to a municipality with the promise of a certain amount of interest payments over a time period that is determined at the time of purchase.  When the time ends, the bond is at it’s maturity date and your original investment will be returned to you in full.

While municipal bonds are offered in taxable and tax-exempt forms it are the tax-exempt bonds that most people will look at.  The income that is generated is generally exempt from any federal taxes and in some states exempt from state and local income taxes. 

The tax-free municipal bonds are offered in two different ways.  The general obligation bond that is issued so that the municipality can raise immediate capital to cover some expenses is basically supported by the issuers taxing power. Revenue bonds, which primarily are issued to fund infrastructure are supported by the money that these projects generate.  These are really attractive to some investors as the issuers have a track record of repaying their debts.

There are some risks involved when purchasing municipal bonds. 
  • Credit Risk.  It’s important that the issuer of the bond is able to meets its financial obligations.  There is a rating system for bonds and anything rated BBB or above is generally considered a good investment. 
  • Interest Rate Risk.  Most municipal bonds have a fixed rate interest.  During the life of the bond the interest rate never changes.  The problem arises when the marketplace interest rates rise which will result in you receiving a lower yield then if you had a new bond.
Other risks include a tax bracket change, a call risk, and market risk.  All of these risks have to be looked at before buying a municipal bond or bonds. If the benefits outweigh the risks for some particular tax-free municipal bonds you will end up receiving profit without making much effort.
 
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