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Nicholas
P. DiNatale, CPA - News and Featured Articles A Primer on Municipal
Bonds Has tax time left you straining for strategies to ease next year’s bite? Then you may want to consider one of the few investments outside of your retirement plan that offers a tax advantage: municipal bonds or funds that invest in them. Many investors think of so-called "muni" bonds as conservative investments that offer poorer yields than taxable Treasury, mortgage-backed or corporate bonds. What many don’t realize, however, is that for investors in tax brackets from 28 percent on up, municipal bonds’ lower tax-free yields may provide more income after taxes than higher-yielding taxable bonds.* The following questions and answers will help you learn more about municipal bonds and determine if they could be a wise investment for you. Q.
What are municipal bonds? There are two basic types of municipal bonds: general obligation and revenue issues: General obligation bonds, or G.O. bonds, are approved by local voters and backed by the full faith and credit of the issuing government. These are usually considered the safer of the two types because the issuer can, if necessary, use its taxing power to pay the bonds’ interest and principal. Revenue bonds are backed by the revenue produced by the financed project – such as a hospital, highway, stadium, airport or public housing. This type may be considered slightly riskier because repayment relies on the health of the project and its revenues; the bonds are not considered an obligation of the local government and taxpayers. To compensate for this additional risk, the bonds often pay a slightly higher yield than G.O. bonds. According to the Public Securities Association, approximately 40 percent of all new municipal bond issues are insured, with scheduled interest and principal guaranteed by one of the several Triple-A municipal bond insurers. In addition, most issuers are evaluated by credit rating firms such as Moody’s Investors Service, Standard & Poor’s Corporation and Fitch Investors Service. Q.
In what form are municipal bonds issued? You can also buy munis through a tax-exempt municipal bond mutual fund. With a fund, you’ll likely enjoy lower investment minimums and diversification across an entire pool of bonds, professional management and easy liquidity. To take advantage of triple tax exemption, buy shares of a bond fund that invests only in issues exempt from state and local taxes within your state of residence. (Certain income may be subject to the alternative minimum tax or state and local taxes.) Q.
Are munis right for me? For example, assume you are in the 36 percent federal tax bracket, have $30,000 to invest and are comparing a tax-exempt bond yielding 6 percent and a taxable corporate bond yielding 8 percent. If you buy the municipal bond you would earn $1,800 annually in interest, a 6 percent yield and pay no federal taxes. The 8 percent taxable bond investment, however, would provide you only $1,536 in income after $864 in federal income taxes have been deducted – a 5.1 percent after-tax yield. The muni bond would be an even better investment if you accounted for state and local income taxes when calculating returns on the taxable investment. Q. Where
can I obtain municipal bonds or a bond fund? * Municipal bonds are subject to federal capital gains and losses — interest income is tax-exempt. Back
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