What are municipal bonds?

Municipal Bonds, also known as ‘muni bonds’ or ‘munis’, are debt securities issued by a state, municipality, or county to finance infrastructures, such as the construction of highways, bridges, or schools. The best way to think about them is that they are loans issued to local governments to cover expenses. These bonds are often exempt from federal taxes as well as most state and local taxes, making them highly sought after for those in higher tax brackets. 

What is the difference between general obligation and revenue bonds?

There are two types of municipal bonds – general obligation bonds and revenue bonds. A general obligation bond is issued by government entities and is not backed by revenue from a specific project. Some of these bonds are backed by property taxes, but others are payable from general funds. A revenue bond secures principal and interest payments through the issuer.

How do you buy a municipal bond?

There are many different ways to buy a municipal bond, such as:

  • Using the services of a broker-dealer or bank that deals municipal securities
  • Hire an investment advisor to locate and trade bonds
  • Trade online through a self-managed account
  • Buy or sell shares in a municipal bond mutual fund
  • Buy or sell shares in a municipal bond exchange-traded fund

When deciding how to buy municipal bonds, look at each of your options and compare the fees associated with each option in order to determine your best path.

How can I benefit from municipal bonds?

Municipal bonds are relatively low risk and the interest earned on the bond is tax-free. These bonds can be extremely beneficial to those who sit in a higher tax bracket as well as retirees who want a relatively low-risk investment in retirement. 

What do municipal bonds finance?

Municipal bonds fund day-to-day obligations for cities, counties, and other government projects such as schools, highways, and sewer systems. Overall, the money earned from the sale of a municipal bond is used to build infrastructure in your area. 

Is investing in municipal bonds safe?

The risk for municipal bonds is relatively low compared to corporate bonds, but revenue bonds are more vulnerable to changes than general obligation bonds. While the majority of municipalities have improved their credit ratings since 2008, it does not mean that default risk is completely eliminated. Whether municipal bonds are truly safe or not depends on your financial situation and future goals. 

Can I sell my municipal bonds before maturity?

You can sell your municipal bond before maturity, but there are a few risks associated with doing so. While municipal bonds do not carry early redemption penalties, you may have some financial costs associated with the sale, especially if you use a broker. When you cash in your municipal bonds, you lose all rights to any future interest payments. You run the risk of receiving less than what you paid for the bond if you sell the bond when interest rates are higher, whereas, at maturity, you would recoup that principal regardless. It’s also important to remember that although the interest on a municipal bond is tax-free, the capital gain is not. If you sell a bond for more than you purchased it for, you must still pay taxes on the difference. By holding onto the bond through maturity, you can usually avoid this tax. 

Who owns municipal bonds?

Around 72% of municipal bonds are owned directly by individuals or through mutual funds. Two-thirds of these owners are over 65 and roughly 40% of interest paid is to households with a yearly income of less than $200,000. 

About 25% of municipal bonds are owned by businesses and banks. 

Should I invest in municipal bonds?

The answer to this depends on your current financial situation and your future financial goals, but municipal bonds are among the safest investment vehicles. They offer substantial tax advantages. Although these benefits lead to lower returns, your returns are tax-free. 

Contact Carty & Co

Carty & Company has been helping clients meet their financial goals and make successful investments since 1970.  If you have questions about how municipal bonds might help you secure your financial future and generate tax-free income, our experienced financial professionals can provide the answers you need to make the best decisions for you and your family’s future.  Contact us today.