Is It Time to Look at Municipal Bonds?

Taxpayers in the upper income brackets are discovering that finding alternatives for tax relief may be a little like looking for the hard-to-find character in “Where’s Waldo?” Fueling their search may be a desire for a tax-efficient investment they can access without paying penalties—before retirement. Or, they may simply want relief from seeing every dollar they invest taxed. In their search, many are discovering one successful way to achieve their goals may be through municipal bond mutual funds.


What are “Munis”?

Municipal bonds (“munis”) are debt obligations issued by states, municipalities, and municipal agencies to raise money to help fund public projects such as schools, hospitals, highways, bridges, water and power facilities, and transportation systems. Interest payments on municipal issues are usually free of Federal taxation, and will typically be free of state and local taxation for investors residing in the state where the bonds are issued.

While it is possible to purchase munis on a single issue basis, it may be easier for the individual investor to buy a muni bond fund. Tax-exempt bond funds offer investors: access to a more diverse portfolio of municipal bonds; protection against loss; and professional management of funds invested.


Is It in My “Interest”?

Municipal bonds usually provide lower interest rates than fully taxed bonds, to which their interest rates are often measured and compared. These lower interest rates can be viewed as a trade-off for their privileged tax status.

As with all bonds, municipal bonds are subject to price fluctuations as interest rates rise and fall. As interest rates fall, bond prices typically rise; if interest rates begin to rise, bond prices fall. Short-term bonds will feel less effect than long-term bonds, but all will react to interest rate changes.


Are They Truly Tax Free?

While municipal bonds are generally exempt from Federal taxation, some income from them may be taxed if an investor faces paying the alternative minimum tax (AMT). In addition, investors are subject to capital gains taxes on any gain realized from the sale of their tax-exempt bond fund shares.

Higher income retirees may also have to pay income tax on up to half of their Social Security benefits if their total income, including tax-free interest from munis, exceeds certain levels.


A Wise Investment for You?

It is important to note that bonds sold prior to maturity may subject the investor to market risks. For many investors, municipal bonds offer yet another option to help fund their goals and objectives. However, like any investment, there are inherent risks associated with bonds. A frequent review of your financial strategy may help ensure that you reduce your exposure to such risks and allow for a more positive return on your investment.

Investors should carefully consider investment objectives, risks, charges, and expenses. This and other important information is contained in the fund prospectuses and summary prospectuses, which can be obtained from a financial professional and should be read carefully before investing.