Earn Tax Free Income with Tax Free Bonds

 

investing in tax free bonds

After the past year of massive turmoil in the economy and the markets, investors are wondering where they can invest in tax free bonds that is relatively safe and smart and provide a higher return than cash. 

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Tax-free bonds can provide some stability and a reasonable after-tax return for many investor portfolios. It is a virtual certainty that income in tax free interest rates will be going up (especially for the "rich") over the next few years to pay for all the huge government borrowing and spending that is going on right now. 

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Social security and Medicare also need increased "funding" from tax revenues. Increasing income tax rates make buy tax-free bonds in india more attractive relative to other investments.

Historically government bonds investment have performed well during periods of rising tax rates. Tax Free bonds appear attractive relative to India government bonds and cash right now because they offer higher yields, lower taxes, and only slightly higher risk (depending on the state) in my opinion.

Tax Free Bond Investing Basics

1. Credit risk.

How safe is the state development loans that is standing behind the buy bonds? My advice right now with all the municipal budget shortfalls is to stick with safer credits and higher rated bonds. Government bonds are usually safer than revenue bonds because they have the full taxing authority of the state behind them.

2. Interest rate risk.

Bond prices move in the opposite direction of interest rates. How much your bond price will go up or down is directly related to how long the term of the bond is. Long yield bonds (10-20 years) are much more volatile (risky) than shorter term bonds (1-5 years). 

I recommend sticking with the relatively safer short-term or intermediate term bonds. Generally the more credit risk and the longer the maturities of the bonds you hold, the higher the yield on the bonds. Higher risk=higher yield.

3. Is It All Tax-Free?

If you buy tax free bonds your interest income will be free of federal income taxes (but not state income taxes). If you buy government bonds fund that owns bonds from your home state this interest income will likely be "double-tax free" for both federal and state income tax.

4. Your Income Tax Rate?

Tax Free bonds make more sense if you are in a high tax bracket. If you are in a low income tax bracket you may be better off (after taxes) owning taxable bonds. Right now muni bond yields are very attractive relative to taxable bond yields so that muni bonds make sense for investors even in some of the lower tax brackets.

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5. Where Should I Own Them?

Tax Free bonds should be owned in your taxable brokerage accounts, and not in your IRA or 401K accounts because income in those accounts is already tax-deferred.

6. Tax-Equivalent Yield? What's that?

To compare the yield on a tax free bond to a taxable bond you take the muni bond yield and divide it by the inverse of your marginal tax rate. 

7. Should I buy individual bonds or tax free bonds?

The benefits of investing in tax free bonds is that you can avoid the fund expense ratio and can pick and choose which states, maturities, and credits you want. You can create your own customized tax free bonds portfolio from bondsindia. 

The advantage of buying tax free bonds in India fund is that you get professional management, increased diversification, and a simpler and easier investment process for you. For most investors who are not bond experts using a tax free bonds fund will likely be best.