It means that the issuer can cancel the issue, pay off the principal and stop the interest payments. The issuer wants that option, in case interest rates drop substantially, giving it the opportunity to issue a new bond at a lower interest rate. Most municipal bonds are callable. Their investors will get their money back, but they'll have to find a new way to invest that money.
A new investment in bonds will earn them less. The alternative minimum tax can be a tax trap for muni bond investors who have very high income from tax-shielded sources. As noted above, tax-free muni bonds are not always entirely tax-free. Bonds are particularly attractive to senior citizens seeking a steady stream of income for their retirement needs. That makes Social Security income the most common pitfall for muni bond investors. Although the bonds are income-tax-free at the federal level, the income from muni bonds is counted towards the investor's adjusted gross income.
A higher adjusted gross income can raise the portion of the taxpayer's Social Security income that is taxable. High-income individuals also can run into the alternative minimum tax, which is aimed squarely at taxpayers with substantial income from tax-shielded sources.
An investor can buy and sell bonds directly through an online brokerage account. They also can be purchased through a full-service brokerage or a bank. Another option is to invest in an exchange-traded fund ETF or mutual fund that invests in muncipal bonds. Here are the answers to some commonly asked questions about municipal bonds. In late , interest rates were rising, and municipal bond rates were rising along with them.
As of Oct. A year AAA-rated bond returned 1. You can lose the money you invest in municipal bonds if the issuer defaults. That risk is vanishingly small, considering that defaults on municipal bonds reached 0. You also could lose money on muni bonds if you are forced to sell the bonds on the secondary market at the wrong time.
The price you get will be determined by the total dollar amount of the remaining interest payments due, factoring in the prevailing rates available on new issues. The best muni bonds from any issuer are rated AAA.
They are issued by state and local governments nationwide and their bonds have been deemed AAA by one of the major rating agencies. When a government runs into economic trouble, its bond ratings suffer but it also will pay a better interest rate in order to attract buyers. After its bankruptcy, the city of Detroit missed payments on three of its general obligation bonds.
That means it was responsible for three out of seven defaults on muni bonds rated by Moody's Investors in that year. Its outstanding debt was rated BB-. A bond rated AAA or close to it is one of the best municipal bonds. A bond issued by a local government that is teetering on the brink of bankruptcy is one of the worst. Investors who don't care to keep an eye on the finances of state and local governments they invest in can invest in a bond mutual fund or ETF.
It will be managed by someone who gets paid to pay attention to these things. A municipal bond, or any bond for that matter, is safe as long as its issuer does not financially collapse. Luckily, that's highly unlikely in the U.
The bond investor's best protection is to take care:. Municipal or corporate bonds are a great alternative for investors who want to create a reliable stream of income, particularly during their retirement years. Highly-rated bonds are by their nature very safe investments compared to almost any other alternative and especially compared to stocks.
Municipal bonds are, as advertised, free of federal taxes. That doesn't mean that the overall return on a muni bond will be the best available option for you. You still have to do your due diligence to choose the best municipal or corporate bonds for you or the best mix of the two. Another alternative is to invest in a bond ETF or mutual fund and let someone else make the choices.
Municipal Bonds. Internal Revenue Service. Accessed Feb. Securities and Exchange Commission. US Inflation Calculator. Lord Abbott. FMS Bonds Inc. The Detroit News.
Top Mutual Funds. Fixed Income Essentials. You'll often hear that to grow serious wealth, you can't tie up the bulk of your money in bonds. The reason? Though stocks are more volatile than bonds, they tend to deliver a much higher return on investment, and that's the boost your money needs to grow over time. But that doesn't mean you shouldn't put any money into bonds. Quite the contrary: Bonds are a good way to generate consistent income in your portfolio, since they pay interest twice a year.
And because they're a safer investment than stocks, they're especially appropriate for near- and current retirees. Still, not all bonds are created equal, and while you may be inclined to buy corporate bonds -- those issued by companies to raise capital -- it actually pays to look at municipal bonds instead.
Municipal bonds are those issues by states, cities, and other localities to raise money for public projects. Municipal bonds come in two main varieties: generation obligation bonds, which aren't tied to a specific revenue stream, and revenue bonds, which are linked to a specific revenue-generating project, like a new bridge or toll road.
Municipal bonds have historically low default rates, which means that if you choose to invest in them, you're likely to get all of your interest payments on schedule, especially if you choose bonds with a high credit rating. But here's where municipal bonds have a major advantage over corporate bonds: You'll get a huge tax break for putting them in your portfolio.
The interest you earn from corporate bonds is subject to taxes -- there's no getting around it. On the other hand, municipal bond interest is always exempt from taxes at the federal level. Furthermore, if you buy municipal bonds that are issued by the state you reside in, you'll avoid state and local taxes on that interest as well. That's a good thing if taxes are a concern for you, whether because you're already in a high bracket or you're worried about paying them during retirement.
When your state plans to undertake a major infrastructure project or your city needs to upgrade public buildings or the sewer system, they may need to raise money for these projects. Municipal and state governments will put a bond issue on the ballot, and voters in an election determine if bonds can be issued for the project.
Investors can buy municipal bonds individually or invest in a municipal bond fund. Learn more about municipal bond funds, how they function, and the pros and cons of investing in them.
State, county, and city government entities often take on debt to fund ongoing operations or large projects. This time frame can range from one to three years for short-term bonds to more than a decade for long-term bonds. The government uses its taxing power or revenue generation to pay back the bonds to investors with interest.
General obligation bonds are paid back with taxes, and revenue bonds are paid back with revenue generated by the government. An example of a revenue-backed bond would be using highway tolls or express lane fees to return principal and interest back to the investors.
Instead of investing in individual municipal bonds, you can put your money in a municipal bond fund. Some bond funds spread their exposure across different types of bonds, such as municipal bonds, corporate bonds, or mortgage-backed securities. Others keep their assets in an exclusive category.
Investors seeking tax advantages often buy municipal bonds. If you're considering doing the same, reach out to a tax professional to discuss the tax implications of any bond you're considering buying. Tax advantaged : Generally, the interest you earn from your investment in a municipal bond or bond fund is exempt from federal taxes.
If you live in the state where the bond was issued, you might also be off the hook for state and local taxes. Investors focused on a steady and reliable stream of income may want to look to municipal bond funds. Steady rate of return : In general, municipal bond funds offer consistent and predictable returns over time. The returns may not be as high as more volatile investments like stocks, but they tend to outpace conservative products like certificates of deposit.
Historically low risk : While municipal bonds do come with some element of risk as almost all investments do, they are known to be a lower-risk investment choice because they have a specified maturity date and are designed to protect the principal investment. Diversification : Investors who have high-risk investments such as company stocks may wish to include municipal bonds in their investments to balance and diversify their portfolio.
Lower yield : Municipal bond funds tend to pay lower yields than other types of bond funds. Non-recourse bonds : Some revenue-backed bonds are not obligated to pay the bond holder if the revenue stream the government intended to use to pay back the investor dries up e. Credit risk : While municipal bonds are not considered high risk, a few publicized incidences of cities or counties not being able to pay back bondholders have occurred.
An entity might do this when interest rates drop below the interest rate the bond offers to save money on interest payouts. In a rising interest rate environment, municipal bond share prices tend to fall.
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