Municipal Bonds, Bond Market, Corporate Bonds, Treasury Bonds, Treasury Bills, Treasury Notes   Municipal Bonds, Bond Market, Corporate Bonds, Treasury Bonds, Treasury Bills, Treasury Notes 
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Municipal Bonds

Home > Bond Market > Municipal Bonds

Municipal Bonds, Bond Market, Corporate Bonds, Treasury Bonds, Treasury Bills, Treasury Notes
Municipal bonds are typically issued to finance certain government functions. Most of them are still exempt from federal income taxes and, in certain instances, free of state and local taxes as well.

Depending on their quality, municipal bonds have historically yielded between 65 percent and 80 percent of the return available on taxable bonds with comparable maturities. If you're in the 28 percent tax bracket, municipal bonds are probably your best bond investment as long as the bonds' yield exceeds 72 percent of the yield on a taxable bond of similar quality and maturity.

The tax code splits municipal bonds into four different categories, each of which are treated differently for tax purposes. However, the law contains a host of exceptions and special rules that make it difficult to determine into which category certain types of issues fall. If you decide to buy a municipal bond, make sure the prospectus includes an outside legal opinion concerning which category the bond will fall under and how the government will treat your earnings at tax time.

Types of municipal bonds
The first category of municipal bonds consists of "public-purpose" bonds that are issued directly by state or local governments or their agencies to pay for basic government functions, such as building highways or schools. Virtually all of these bonds remain tax-exempt.

The second type of municipal bonds is issued for what Congress considers "non-governmental purposes," or "private activity," such as raising money for student loans or low and moderate-income housing. Yields on these bonds typically are one-half to three-quarters of one percentage point higher than yields on public-purpose bonds, primarily to compensate high-income investors who have to treat the interest payments on these bonds as taxable income in calculating their alternative minimum tax. If you make enough money to warrant buying a municipal bond but aren't so rich that you may have to pay the alternative minimum tax this type of bond may be a very good investment.

The third category of municipal bonds finances what Congress considers non-essential services, such as building a new sports arena or convention center. Although these municipal bonds are free from state and local taxes in the state where they are issued, they are subject to federal tax. As a result, interest rates on these municipal bonds are usually higher than rates on other types of municipals, but lower than rates for bonds taxed on both the federal and state levels.

Municipal bond funds and trusts
You can also invest in municipal bonds through a municipal bond fund or trust. With these, you can either arrange to receive the interest each month or automatically reinvest the interest in a similar type of investment. Your minimum investment can be as low as $1,000, depending on the sponsor's investment requirements.

Funds and trusts "pool" investors' money and use the cash to buy several different municipal bond issues. A fund provides continuous management of the portfolio; its manager can buy or sell certain issues as market conditions change. A trust, on the other hand, holds the bonds it purchases until they mature. You'll get a better return from a fund if the fund's manager is a skilled bond trader. However, your return from a fund will be lower than a trust's return if the fund's manager makes poor investment decisions.

Funds and trusts allow you to reduce your investment risk because of their diversity. However, you pay for that diversity through up-front commissions or annual management fees. Either way, your income will come to you with all the tax advantages you'd enjoy if you purchased the bonds yourself.

The tax implications of investing in municipal bonds are important, regardless of whether you buy them yourself or invest in them through a fund or trust. As a result, you should consult with an accountant or other qualified professional before you invest in municipal bonds, and seek your adviser's help when it's time for you to file your tax return.

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