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Tax-free municipal bonds

by vjz 14y ago

aantix 14y ago
Care to expand on this?
- brianobush 14y ago
  Municipal bonds, loans to your local government are free of taxes (both state and fed). I have excess cash that would normally be in certificate of deposit in muni bonds currently making 3% tax free. There are risks, best to consult with a money manager if you are uncertain on how to gauge the associated risks.
  - nandemo 14y ago
    Indeed, municipal bonds are much riskier than good ol' Treasuries. http://www.nytimes.com/2012/08/16/business/municipal-bonds-default-more-than-advertised.html http://www.nytimes.com/2012/08/16/business/municipal-bonds-d...
    - brianobush 14y ago
      The key is diversity; I use municipal bond funds and have had great success and much more income than from treasuries.
- hkhanna 14y ago
  State and municipality bonds are sort of like U.S. Treasury bonds, except they're issued by a state or local government. They pay a fixed interest rate, but your interest is usually tax-free. Of course, they pay a lower interest rate than taxable bonds. Thus, the only reason these tax-free bonds would be better than taxable bonds is if you are in a high enough marginal tax bracket to compensate for the difference in interest between these tax-free bonds and taxable bonds. An example should make this all clear. Assume you have a marginal tax rate of 40%. (You earn a lot of money.) If you invest $100,000 in a typical taxable bond that pays 10%, each year you will get $10,000. But subtract out the 40% tax, and you are left with only $6,000 after-tax. Compare this with what would happen if you invested that same $100,000 in a tax-free state bond. This bond only pays 8%, being tax-free and all. Each year you get $8,000. But you pay no tax, so you are in fact better off than if you had bought the taxable bonds! Now, lets change your marginal tax bracket to 10%--you don't earn much money, so your marginal rate is low. You invest that same $100,000 in the taxable bond that pays 10%, you will get $10,000 pre-tax but only pay your marginal rate, 10%, on that sum, so you are left with $9,000. With the tax-free state bond at 8%, you only get $8,000, though you don't pay any tax on it. So at your low marginal rate, you would have been better off buying the taxable bond. My point is, tax-free bonds are probably only useful if you earn a lot of income each year to put you in a high marginal rate. Source: I'm a law student and we learned about tax-exempt state/municipal bonds today in Tax!
  - nlh 14y ago
    Excellent explanation - thank you for the write-up! Now if only we could find those muni bonds that pay 8% ;)
    - curiouscats 14y ago
      True. Just wait, it will happen eventually. But until then, sadly, decent income producing investments (bonds and the like) are not easy to find.
  - deleted 14y ago
    [deleted]
adaml_623 14y ago
And I assume that if your state goes bust then they haircut or default on the bonds? So how do you price that risk?

Tax-free municipal bonds

by vjz 14y ago

Tax-free municipal bonds

aantix 14y ago

Care to expand on this?

brianobush 14y ago
Municipal bonds, loans to your local government are free of taxes (both state and fed). I have excess cash that would normally be in certificate of deposit in muni bonds currently making 3% tax free. There are risks, best to consult with a money manager if you are uncertain on how to gauge the associated risks.
- nandemo 14y ago
  Indeed, municipal bonds are much riskier than good ol' Treasuries. http://www.nytimes.com/2012/08/16/business/municipal-bonds-default-more-than-advertised.html http://www.nytimes.com/2012/08/16/business/municipal-bonds-d...
  - brianobush 14y ago
    The key is diversity; I use municipal bond funds and have had great success and much more income than from treasuries.
hkhanna 14y ago
State and municipality bonds are sort of like U.S. Treasury bonds, except they're issued by a state or local government. They pay a fixed interest rate, but your interest is usually tax-free. Of course, they pay a lower interest rate than taxable bonds. Thus, the only reason these tax-free bonds would be better than taxable bonds is if you are in a high enough marginal tax bracket to compensate for the difference in interest between these tax-free bonds and taxable bonds. An example should make this all clear. Assume you have a marginal tax rate of 40%. (You earn a lot of money.) If you invest $100,000 in a typical taxable bond that pays 10%, each year you will get $10,000. But subtract out the 40% tax, and you are left with only $6,000 after-tax. Compare this with what would happen if you invested that same $100,000 in a tax-free state bond. This bond only pays 8%, being tax-free and all. Each year you get $8,000. But you pay no tax, so you are in fact better off than if you had bought the taxable bonds! Now, lets change your marginal tax bracket to 10%--you don't earn much money, so your marginal rate is low. You invest that same $100,000 in the taxable bond that pays 10%, you will get $10,000 pre-tax but only pay your marginal rate, 10%, on that sum, so you are left with $9,000. With the tax-free state bond at 8%, you only get $8,000, though you don't pay any tax on it. So at your low marginal rate, you would have been better off buying the taxable bond. My point is, tax-free bonds are probably only useful if you earn a lot of income each year to put you in a high marginal rate. Source: I'm a law student and we learned about tax-exempt state/municipal bonds today in Tax!
- nlh 14y ago
  Excellent explanation - thank you for the write-up! Now if only we could find those muni bonds that pay 8% ;)
  - curiouscats 14y ago
    True. Just wait, it will happen eventually. But until then, sadly, decent income producing investments (bonds and the like) are not easy to find.
- deleted 14y ago
  [deleted]

adaml_623 14y ago

And I assume that if your state goes bust then they haircut or default on the bonds? So how do you price that risk?