Municipal Bonds - Understanding Tax Free Municipal Bonds
Municipal bonds and notes are issued by state and local
governments. These municipalities include:
Counties and Cities
Towns and Schools
Interest payments on traditional municipal bonds are exempt
from federal tax. They are subject to state and local tax.
Tax Free Yield
When looking to purchase muni bonds, a person should understand
how tax exempt yields work. The higher the tax bracket, the
higher the yield. If an investor is considering buying a 6%
municipal bond at par and they are in the 28% tax bracket, the
tax free yield would be higher than 6%. The formula is:
Municipal stated rate or coupon divided by 100 minus the tax
The calculation would break down like this:
6% divided by 72 (100-28), which equals 8.33%. This means that
to achieve a better return than this 6% coupon bond, you would
need equal to or better than 8.33% in a taxable investment. A
lower tax bracket would show a lower tax free yield.
Type of Municipal Issues
There are two main types or ways a municipality can guarantee or
back it's bond. One way is through the taxing power of the
municipality. This would be called a General Obligation
Bond or G.O. Bond. Another is called a Revenue Bond,
which uses specific revenue sources to secure the issue.
General Obligation Bonds
These are the most common and normally the better rated issues.
A state raising money and backing the bond issue with higher
income or sales tax would be considered a G.O. Bond. A school
district rasing money through a broker dealer on a municipal
bond and securing the bond investors with school or property tax
revenue is considered a General Obligation bond as well. Since
taxes are the most secure source for money now and in the
future, some investors prefer them over most revenue issues.
Issues that rely on the revenue producing ability of a facility
or from the issuer through other means are Revenue Bonds. There
are several types of issuers. These would include:
Transportation - Bridges, Tolls, and Airports would be good
Health care - City or county hospitals
Utility Companies - Electric or water companies could assess
usage increases to raise money.
Industrial - Some municipal issuers will work with private
companies and use the company's lease payments to the city as a
revenue source for bond issues.
Triple Tax Free Municipal Bonds
Investors who buy municipal securities issued within their own
state are exempt from federal, state and local taxation. An
investor in California should consider buying California
municipal bonds above issues from outside the state. Retail or
individual investors should only buy from within their state
because of this. Larger institutions will normally buy from all
over the country.
Municipal bonds should be a part of most investor portfolios.
They are also a way of supporting your local area.
For more information visit: Muni Bonds at