Often times, clients ask how can I invest money on a tax favorable basis? For now, let's assume they are already contributing to a 401k, an IRA or a Roth. My immediate response if typically, " Well, let's talk Municipal Bonds. "
First Off, What Is A Municipal Bond? By definition, a municipal bond is a debt security issued by a state, municipality or county to finance its capital expenditures, including the construction of highways, bridges or schools. Municipal bonds are exempt from federal taxes and most state and local taxes, making them especially attractive to people in high income tax brackets. Essentially, a security issued by or on behalf of a local authority.
There are various types of Municipal Bonds.
A municipal bond is categorized based on the source of its interest payments and principal repayments. A bond can be structured in different ways offering various benefits, risks and tax treatments. Income generated by a municipal bond may be taxable. For example, a municipality may issue a bond not qualified for federal tax exemption, resulting in the generated income being subject to federal taxes.
A general obligation bond (GO) is issued by governmental entities and not backed by revenue from a specific project, such as a toll road. Some GO bonds are backed by dedicated property taxes; others are payable from general funds.
A revenue bond secures principal and interest payments through the issuer or sales, fuel, hotel occupancy or other taxes. When a municipality is a conduit issuer of bonds, a third party covers interest and principal payments.
Municipal Bond Investments, do not come without risk however. Some of those risks may included, but are not limited to.....
Default risk is low for municipal bonds when compared with corporate bonds. However, revenue bonds are more vulnerable to changes in consumer tastes or general economic downturns than GO bonds. For example, a facility delivering water, treating sewage or providing other fundamental services has more dependable revenue than a park's rentable shelter area.