Investing in Tax-Free Municipal Bonds

Towns, cities, and regional and local agencies issue municipal bonds. Municipal bonds usually have lower interest rates than comparably rated corporate bonds and Treasury securities. The minimum amount required for investment in municipal bonds is $5,000, and municipal bonds are sometimes issued at a discount. This discount compensates investors for the additional risk that these bonds may have due to the financial difficulties of some local governments.

The most important feature of municipal bonds is their tax-exempt feature. In subsequent judgments based on the 1819 McCullough v. Maryland ruling, the Federal, state, and local governments don't possess the power to tax each other. Consequently, municipal bonds can't be subject to Federal tax.

Additionally, income from state and local municipal bonds can't be taxed if purchased within the geographic area. For example, Virginia residents don't pay state taxes on Virginia bonds. However, residents of California are subject to state income taxes on their Virginia bonds.

The tax-exempt feature makes municipal bonds very attractive to investors in high tax brackets. You treat capital gains on such bonds as normal income.



Muni types
Three primary types of municipal bonds exist. Each bond type has special features:


General obligation bonds are backed by the full faith and credit of the issuing agency. For municipal bonds, full faith and credit also means the taxing power of the issuing municipality.


Revenue bonds are backed by the funds from a designated tax or the revenues from a specific project, authority, or agency. These bonds are not backed by the full faith and credit (or the taxing power) of the issuing agency. In other words, revenue bonds are only as good (and as creditworthy) as the ventures they support.


Industrial development bonds (IDBs) are used to finance the purchase or construction of industrial facilities that are to be leased to businesses. Leasing fees of the facilities are used to meet construction expenses and the repayment requirements of the bonds. Often, these bonds provide inexpensive financing to firms choosing to locate in the geographical area of the issuer. Examples of IDBs are bonds for the construction of piers and wharves.

Municipalities can also issue short-term securities called tax-exempt commercial paper and variable-rate demand obligations.

The Bond Market Association/Bloomberg National Municipal Bonds Yields provides investors with an overview of the national municipal bonds yields for triple A-rated, tax-exempt, insured revenue bonds. This information is designed to be used as a benchmark for particular categories of municipal bonds. Benchmarks are useful when you are determining whether a municipal bond is priced above or below the average market rate.

Online muni bond brokerages
The following brokerages provide a variety of bond information such as frequently updated offerings for individual investors, informative articles, and starter kits. The offerings shown at these Web sites are used for information purposes only. The securities listed by these firms are subject to changes in price and availability.


First Miami Securities is a financial institution that provides tables and charts of investment-grade municipal bond yields, among other things.


Lebenthal & Company will send you a "Bond Kit" that is designed for first-time municipal bond purchasers. The Bond Kit covers general obligation and revenue bonds, bond insurance, coupons, taxes, and how to sell your bonds.


Stone & Youngberg offers weekly listings of mortgage-backed securities, corporate bonds, and municipal bonds. At the home page, click Weekly Market Update for the listing of the municipal bond type you are researching.