“No one wants to pay more taxes than necessary, the net yields on some Municipal Bonds may be far less than a taxable choice.” — Lawrence Castillo
Municipal securities, also known as “munis,” are bonds issued by governmental entities such as states, cities, counties and other organizations.
The bonds are sold to raise money for public interest projects, such as schools, bridges, roads and other municipal construction needs to benefit the public. Like all bonds, munis pay a specified amount of interest (usually semiannually) and return the principal to the bond owner on a future specific maturity date. Most municipal bonds are sold in minimum increments of $5,000 and have a maturity date that can range from 10 to 30 years.
When considering investing in municipal bonds, find the financial strength of the municipality issuing the bond. Financial ratings should be considered.
Municipal bonds are rated by independent agencies that evaluate the ability of the entity to repay the bond. Be sure the information regarding the repayment ability is up to date.
Liquidity and the ability to find a buyer for the bond in the event of a need to sell should be a well thought out consideration.
No municipal bond is like another; differences should be evaluated. Some bonds are traded actively, while others may have no activity for weeks at a time.
As a general category, municipal bonds may tend to be more sensitive to supply and demand than other fixed-income categories. This should also be a consideration when evaluating market risk. Can the municipal bond be sold if needed And of course, like all bonds, municipal bonds are subject to interest rate risk — if rates rise above the rate of your bond, the value of the bond in the secondary market declines.
A tax advantage may be the primary reason most individual investors invest in municipal bonds. Municipal bonds have a tax advantage on earned interest; the earned interest is a nontaxable event when calculating federal income tax liability.
A crucial point to remember is that not all Munis may be income tax free; there are exceptions, so ask your broker. Also, tax liability from a bond owner’s state of residence is generally a taxable event. Make sure you are completely informed about the advantages and disadvantages of municipal bond ownership.
Another significant tax issue may come into play when you sell your municipal bond. If you sell your bond for more than you paid for it, you could have a tax liability. Profits from the sale of a municipal may come with a tax liability.
The financial strength of a Muni can also affect the overall interest earned. The more secure the credit of the bond issuer, the lower the interest rate earned. Many new issue Munis are paying interest of less than 1 percent, however some may pay more.
Be sure and fully understand all parts of how a Muni works before making a commitment. Many Munis bonds can have a 20-30 year time commitment until maturity.
Another way to accumulate funds long term to reduce your tax liability is to buy fixed-rate annuities. Interest accumulates tax-deferred until monies are accessed; this could be a significant annual tax saving for you. Plus, interest earned in an annuity that is tax-deferred may not count against your gross income when considering tax liability for social security calculations.
Tax issues can be complicated. Always make sure you consult a tax professional before making any permanent decisions.
(Lawrence Castillo is a member of Syndicated Columnists, a national organization committed to a fully transparent approach to money management. L and C Retirement Income Planners, 4801 Lang St., NE, Suite 100, Albuquerque, NM, 87109, 505-798-2592, lawrencecastillo.retirevillage.com)