Earn Tax-Free With Municipal Bonds

Municipal bond issues are a very popular way to earn
tax-free income and, if income is reinvested, achieve
tax-free compounding of returns.

Municipal bonds (also known as “munis”) are fixed-income investments that can provide higher after-tax returns than similar taxable corporate or government issues. In general, the interest paid on municipal issues is exempt from federal taxes and sometimes state and local taxes as well.

Municipal Bonds Defined

A municipal bond is an interest-bearing debt obligation issued by a state or local municipality, which may support general government needs or fund a public works project. A municipal bond can also be issued by legal entities such as a housing authority or a port authority. A variety of projects, such as new roads, stadiums, bridges, or hospitals, are usually financed through the issuance of municipal bonds. In addition to providing tax-exempt earnings, municipals can be an excellent way to invest in the growth and development of your community.

Types of Municipal Bonds

The most common type of municipal is called the general obligation (GO) bond. These bonds are not tied to a particular community project, and the issuer of the GO bonds is obligated to make interest and principal payments on time, which makes them one of the least risky municipal investments. Consequently, they also have lower yields.

Another type of bond is the revenue bond, which is backed only by the revenue expected to be generated by the facility being built. Other types include special tax bonds and industrial revenue bonds, as well as variation on the general obligation bond.

Commercial paper: Short-term debt issued by governments to meet cash-management needs, budget shortfalls, and the like. Typically, they are backed by a bank letter of credit and carry maturities of less than nine months. The yields offered are generally low due to their short maturities.

Private activity bonds: Used to fund private pursuits that qualify under federal law as having a tax-exempt status. They are considered riskier than revenue and general obligation bonds and thus offer higher yields. May not be tax exempt.