The Ins and Outs of Municipal Bonds
Quick Summary: We have talked about two ways to invest, owning and loaning. We will cover real estate later, but one way people invest in a capitalistic system is to invest in corporations, either by owning them (owning stock), or loaning to them (owning bonds).
We spoke of common stock and preferred stock, and then we spoke of bonds.
Let's look at municipal bonds, which offer tax exemptions from income tax.
Municipal Bonds - These are particularly attractive to individuals in higher tax brackets because the interest is federal tax exempt and possible state tax exempt (check with your investment advisor or state taxing entity). To determine what yield a taxable income investment must return to be equivalent to the tax-free return, use the following formula:
Tax-Free Yield (1.00 - Your Marginal Tax Bracket)
Tax-Free Yield Tax Bracket Taxable Equivalent
7% 15% (Divide by .85) 8.24%
7% 28% (Divide by .72) 9.72%
7% 31% (Divide by .69) 10.14%
Types of Municipal Bonds
Revenue Bonds - backed by the revenue created. If the revenue from the municipally backed project (bridges, roads, hospitals) declines, interest to the investor could decline.
General Obligation - backed by the taxing authority of the issuing entity. These bonds are subject to credit risk.
Note: This material is from a manuscript that I created on the subject during my career as a real estate broker and financial planner. My intention is to provide, for those interested, information I have found it to be useful to many people as they pursue financial freedom (even if they are not sure of their goals). While I am still a Certified Financial Planner (as well as a real estate broker), I no longer offer my services to the public, but if I can answer your question, feel free to ask, I encourage you to do so.
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