How to Earn More Returns with Tax Free Municipal Bonds
Diversification is critical to any portfolio’s long-term growth. A good diversification plan includes low-risk investments, such as municipal bonds, or “munis”. Municipal bonds are debt instruments issued by government agencies, such as cities and counties, and are rated just the same as any corporate bond. However, with municipal bonds, you may get an added bonus for your conservative investment – tax exemption!
Most tax free municipal bonds are issued by a government entity who wants to encourage financial investment in community. Your investment dollars in tax free municipal bonds go toward building roads, sewers, and other infrastructure projects. The goal of a tax free municipal bond is to generate income and pay tax exempt dividends to investors. Tax free municipal bonds permit interest yield to be free of federal tax – and sometimes state and local tax as well.
What Qualifies a Tax Exempt Municipal Bond?
Not all municipal bonds are tax free or tax exempt. In most cases, tax free municipal bonds are strictly geared towards public works, where investment dollars go toward projects to improve public infrastructure. These tax free municipal bonds are also called general obligation bonds.
However, the type of project for which a municipal bond is issued can affect the tax status of the bond. A revenue bond is a municipal bond issued to benefit private for-profit activity, such as a baseball stadium or an airport. These types of revenue bonds may be subject to the federal alternative minimum tax.
How Can You Benefit from Tax Free Municipal Bonds?
You can benefit from a tax free municipal bond depending on your tax status. Though tax free municipal bonds do provide all investors with tax exempt status on dividends and interest, not all investors will enjoy the potential yield.
For instance, an investor in a higher tax bracket, say 33%, can most likely enjoy a better interest return on a tax free municipal bond than a corporate bond with a similar interest rate. By contrast, a lower tax bracket investor, say in the 15% range, will not reap as much interest yield with a tax free municipal bond than a corporate bond of the same rate. It is always recommended that you check with an investment broker to determine whether a tax free municipal bond investment is right for you.
Remember that tax free municipal bonds may also be tax exempt from state and local taxes. When investing in tax free municipal bonds, keep in mind the potential state tax burden that can be saved as well.
The tax exemption status of tax free municipal bonds offers a great way for some investors to protect their investment income from double taxation at the federal and state level. Check with your investment broker about how you can allocate part of your portfolio wealth in these tax havens.
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