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Municipal bonds (also known as munis) are attractive to many investors because the interest income is exempt from federal income tax, and in many cases, state and local taxes as well. In addition, munis often represent investments in state and local government projects that have an impact on our daily lives, including schools, highways, hospitals, housing, sewer systems and other important public projects.
The yield on municipal bonds is usually less than the yield you would get from taxable bonds of the same maturities. However, because you don't pay tax on municipal bond income, your actual "net" yield could be higher than the taxable yield you receive from corresponding corporate bonds, depending on your tax bracket.
To calculate your taxable equivalent yield, divide the tax-exempt yield by 1, MINUS your tax bracket. For instance, if you want to buy a municipal bond yielding 4.5%, and you're in the 36% tax bracket, your effective yield would be 5.47%.
Here's the math: 4.5 / (1 - 0.36), or 4.5 / 0.64 = 5.47%. So you would get the same amount of money in your pocket from both a high-quality municipal bond that is yielding 4.5% and a corporate bond that is yielding 5.47%.
As with all taxable versus tax-free decisions, I recommend that you check the taxable equivalent yield before you make your final decision. If munis do make good sense for you, invest in the highest-rated municipal bonds you can find, hold until maturity - and enjoy the tax-free income!
The yield on municipal bonds is usually less than the yield you would get from taxable bonds of the same maturities. However, because you don't pay tax on municipal bond income, your actual "net" yield could be higher than the taxable yield you receive from corresponding corporate bonds, depending on your tax bracket.
To calculate your taxable equivalent yield, divide the tax-exempt yield by 1, MINUS your tax bracket. For instance, if you want to buy a municipal bond yielding 4.5%, and you're in the 36% tax bracket, your effective yield would be 5.47%.
Here's the math: 4.5 / (1 - 0.36), or 4.5 / 0.64 = 5.47%. So you would get the same amount of money in your pocket from both a high-quality municipal bond that is yielding 4.5% and a corporate bond that is yielding 5.47%.
As with all taxable versus tax-free decisions, I recommend that you check the taxable equivalent yield before you make your final decision. If munis do make good sense for you, invest in the highest-rated municipal bonds you can find, hold until maturity - and enjoy the tax-free income!
