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Are municipal bonds for you?

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POSTED: June 16, 2007 5:03 a.m.
You’ve made it through another tax season. If you got a refund, you might be satisfied. But if you’d like to see a different outcome in 2008, review your tax return, including your investment-related taxes. Some investments are more “tax-friendly” than others are. And municipal bonds might be the friendliest.
“Munis” are issued in two main categories: general obligation bonds and revenue bonds. General obligation bonds finance activities of state and local governments, while revenue bonds pay for specific projects, such as airports and other civic facilities.
So, when you buy a muni, you’re supporting a project or service, possibly in your state or community. And you will be rewarded for your civic-mindedness through tax breaks. Specifically, your interest payments will be free from federal taxes. If the municipality that issues the bond is in your state, your earnings also may be exempt from state and local taxes.
Municipal bond interest is free from federal taxes, but some munis — particularly airport and housing bonds — might be subject to the alternative minimum tax. If you think you may have to pay the AMT — and a lot more people are subject to this tax now than in years past — you might want to avoid these bonds. Conversely, if you know you won’t be assessed the AMT even if you bought AMT-subject munis, you might be especially interested in these bonds, because their yields are typically higher than on regular municipal bonds.
In any case, municipal bonds offer benefits beyond tax-free interest. For one thing, munis can help you diversify a portfolio heavily weighted with stocks. Municipal bonds may not be affected by many of the factors that cause volatility in the price of stocks. So, municipal bond prices generally do not move together with stock prices.
Furthermore, munis are among the most secure investments you can own. The default rate on them, especially general obligation bonds, is typically quite low.
Finally, when you’re shopping for municipal bonds, look for quality, those bonds that are rated at least “A” or higher by the major rating agencies.

Cardella is a financial consultant with Edward Jones.
 

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