A Bond Muni or a municipal bond is a debt instrument issued by a local government, city or state in the US. Municipalities use the proceeds to fund projects such as building bridges, repairing roads etc. By investing in a municipal bond, an investor lends money to the municipality and the municipality, in return, offers an interest based on fixed or variable interest rates. This interest income is tax free at the federal level. Depending upon the city or state, the municipality might offer tax free income at local and state levels. Some of these bonds are also subject to Alternative Minimum Tax.
Bond Muni – Advantages of Municipal Bonds
Many investors buy Muni or municipal bonds to enjoy tax benefits and preservation of capital. Muni investors have low default rate in terms of capital preservation. Investors who want to protect their investment can enjoy a certain level of comfort by investing in Municipal bonds since they are not exposed to the amount of credit risks associated with other investment vehicles. These bonds are designed to pay back 100% of the principal at par, when they are called by the issuer or upon maturity. Although there is no guarantee given, similar to US Treasury bonds, the default rate is extremely low.
Bond Muni –Taxability
The taxability of income from municipal bonds depends upon the type of project the issuer is funding. Bonds that are issued to build public goods are normally exempted from federal income tax. If the money is partly or fully aimed at funding projects that will be useful for private parties,and may attract federal taxes. Although the laws related to taxability of municipal bonds differ from state-to-state and can be complex. However, you can find information about their taxability before the bonds are sold in the market. Law firms certify the bonds regarding the taxability before the bonds hit the market.
Since most of the municipal bonds are exempt from taxes while corporate bonds are taxed, directly comparing the coupon rates of municipal bonds and corporate bonds can be misleading. A municipal bond can offer better after-tax yield when compared to the corporate bond of a same coupon rate.Longer-maturity municipal bonds offer substantially higher after-tax yield. However, always remember that not all the municipal bonds are exempted from federal taxes.