Prospectuses can be obtained by contacting us. Expense Ratio — Gross Expense Ratio is the total annual operating expense before waivers or reimbursements from the fund's most recent prospectus.
You should also review the fund's detailed annual fund operating expenses which are provided in the fund's prospectus. This material is not intended as a recommendation, offer or solicitation for the purchase or sale of any security or investment strategy.
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Life events. Life priorities. Investor education. Tools and calculators. Contact us. Open an account with Merrill. Earn tax free income with municipal bonds Share:. Text size: aA aA aA. Nobody likes to pay taxes. That's why investors naturally are interested in earning tax-free income.
Municipal bond issues are a very popular way to earn tax-free income and, if income is reinvested, achieve tax-free compounding of returns. Municipal bonds also known as "munis" are fixed-income investments that can provide higher after-tax returns than similar taxable corporate or government issues. In general, the interest paid on municipal issues is exempt from federal taxes and sometimes state and local taxes as well.
A municipal bond is an interest-bearing debt obligation issued by a state or local municipality, which may support general government needs or fund a public works project. General obligation bonds are used to fund public projects, such as building a park or improving a school system, that don't inherently make money but better the communities they serve.
General obligation bonds are backed by the full faith and credit of the issuer, meaning they're not secured by any specific asset bondholders can repossess. As such, general obligation bonds have been one of the safest kinds of bonds you could buy.
Revenue bonds are issued by municipalities to finance revenue-generating projects like a toll road or concert hall. The cash generated by the project itself will pay back investors in those bonds. Revenue bonds have higher default rates than general obligation bonds since the funds are used for a specific project, which may or may not be completed on time and within budget and may not generate the projected revenues.
So it's important to research the issuer's credit rating before risking your capital. New issues are bonds that a municipality sets up for a new project. The secondary market is where you can buy bonds that are already issued from other investors or sell not-yet-matured bonds you already hold. Bond funds are investments in a fund that owns bonds. You own a stake in the bonds via your ownership of that fund.
In all of these cases, you'll buy and sell through a broker, similar to how you invest in stocks. It's important to understand the fees you'll pay, as well as the potential "markup" -- a selling price above face value -- of the bond.
Brokers who buy and sell municipal bonds are required to register with the Municipal Securities Rulemaking Board MSRB , which governs the muni bond market. They're required to disclose certain pricing information so that you, as an investor, can understand what you're paying. A mutual fund or exchange-traded fund ETF that invests in bonds might be appropriate as well.
Your investment in a muni bond fund gives you a small stake in every municipal bond the fund owns. The benefit is instant diversification , which can help you avoid losses from being too exposed to a single bond. The downside is potentially high recurring fund management fees. On the whole, municipal bonds have a low default rate. Between and , there were only 99 muni bond defaults issued. Of these, only nine general obligation bonds defaulted, and not a single municipal bond with the highest credit rating defaulted.
Municipal bonds have been 50 to times less likely to default than corporate bonds. However, municipal bonds still are not risk-free.
In recent years, some governments have defaulted on their municipal bonds, including Detroit in and Puerto Rico in Municipal bonds generally offer lower interest rates than corporate bonds, although, as with Treasury bonds, that interest is tax-free.
Keep in mind, however, that the tax benefits of municipal bonds only apply to interest payments -- not capital gains. If you sell a bond for more than you paid, those gains are still taxable. Muni bonds carry "interest rate risk " as well.
A revenue bond uses the money generated by the project to fulfill its debt obligations. Examples include a bridge or tunnel that collects tolls or a stadium using ticket sales to pay interest and principal back to investors. Sometimes a municipality issues a revenue bond on behalf of a private entity, such as a university, housing developers or health systems.
These are called conduit bonds. In these cases, the conduit borrower has the ultimate responsibility of covering the debt obligations. Check out the best online brokers. Limited time offer. Terms apply. As with any investment, it's important to weigh the pros and cons of municipal bonds before jumping in. Tax minimization: Many municipal bonds are exempt from federal taxes, and if the investor lives in the same state where the bond is issued, the muni will often be exempt from state and local taxes as well.
Here's how that calculation works:. An investor would need to find a taxable bond yielding 6. Being thoughtful about where they purchase tax-free muni bonds can save investors money. For example, many investors in higher tax brackets strategically buy tax-exempt munis in their brokerage accounts, which are taxable. They put their other less tax-advantaged fixed-income investments in retirement accounts like traditional IRAs and k s that are designed to defer taxes.
Diversification: When it comes to investing, it makes sense to not put all your eggs in one basket and instead diversify your holdings. This helps minimize investment risk across your portfolio. Investors often use muni bonds alongside Treasurys, corporate bonds and other fixed-income securities since they all have different risk and reward profiles. Usually, a muni bond carries slightly more risk and will have a higher yield than a Treasury, but is less risky and will have a lower yield than a corporate bond.
Many municipal bonds can also be considered socially responsible investments if the project they finance aims to do some social good or community development.
Safety: Municipal bonds are considered a relatively safe fixed-income investment. GO bonds are usually considered safer than revenue bonds, as a municipality can raise taxes to cover outstanding debt obligations, whereas revenue bonds are subject to the earnings made by that particular project.
Default risk: While these bonds are a relatively safe investment, municipalities can sometimes find themselves in financial hot water. You might recall headlines about defaults in Detroit in and Puerto Rico in Additionally, the Municipal Securities Rulemaking Board, a regulatory body, maintains a website with disclosure documents, pricing data and other information valuable for muni bond investors.
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