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“Should I Buy a Municipal Bond Fund?”

As a reminder, lately we have been covering a wide variety of topics dealing with minimizing your tax burden from your investments.

Today we discuss one of the most popular tax-free investments, municipal bonds.

Today’s question is:

“Should I Buy a Municipal Bond Fund?”

 

Transcript - Are Municipal Bonds Right For You?

Municipal bonds are one of the very few investments that can be completely tax free.

The federal government does not charge taxes on interest earned on municipal bonds,

And states do not charge tax on the interest on certain bonds issued from municipalities within the state.

So, for someone in a high tax bracket, with lots of investments in taxable brokerage accounts, municipal bonds can greatly reduce your investment related taxes.

But just because an investment is tax free, does not mean that it is a good investment.

The best way to determine if municipal bonds are right for you is by determining an investment’s tax equivalent yield. This will depend on your state of residence, your income, and what you will be invested in.

For example, if you live in California today and have a household income of $180,000 and buy a corporate bond yielding 4%, the interest that you earned on that bond will be taxed at a 24% rate by the federal government, and then 9 point 3 percent by California. So, after all taxes are taken out, your bond produces an after tax return of about 2.6 percent.

So, if you could find a municipal bond with a yield of 2.6%, you would actually get the same after tax return from the municipal bond as on a 4% corporate bond. Or said another way, the tax equivalent yield of a 2.6% yielding municipal bond is 4%.

We have a tax equivalent yield calculator available here.

So, whether or not a municipal bond is right for you depends on your total tax rate, the type of investment, the type of investment account you are using, and where you live.

For clients, we can either select individual municipal bonds in order to get a state tax break, or we use a couple of iShares municipal bond ETFs with the ticker symbols SUB, which is short term municipal bonds, or MUB when are longer maturity municipal bonds.

Matt Hylland