State and local governments often borrow money to supplement tax revenues and to finance projects such as new highways, buildings, or public works improvements. Such bonds are known as municipal bonds ("munis") or tax-exempt bonds.
Most municipal bonds and short-term notes are issued in denominations of $5,000 or multiples of $5,000. Bond interest typically is paid every six months (though some types of bonds work differently); interest on notes is usually paid at maturity.
Municipal bonds are subject to the uncertainties associated with any fixed income security, including interest rate risk, credit risk, and reinvestment risk. However, the tax advantages associated with munis and their potential ability to provide an ongoing income stream have traditionally made munis an important part of a portfolio.
Also, municipal bond interest from a given state typically isn't taxed by governmental bodies within that state, though state and local governments typically do tax munis from other states. However, regulations vary from state to state.
Some states tax both in-state and out-of-state munis, and some tax neither. Consult a tax professional before investing to make sure you understand how your state treats municipal bonds.
Find out more about prudent tax planning strategies.
The tax advantages of municipal bonds mean that even though a muni's coupon rate may be lower than that of a taxable bond, its after-tax yield could be higher, depending on your tax bracket. Generally, the higher your tax bracket, the higher a muni's tax-equivalent yield will be.
To accurately compare a tax-free bond to a taxable bond, you'll need to look at its tax-equivalent yield. To do that, you apply a simple formula that involves your federal marginal tax rate–the income tax rate you pay on the last dollar of your yearly income–and any state and local taxes.
To calculate the yield a taxable bond needs to equal that of a tax-free bond, use the following formula: Add your state and local tax rate to your federal tax percentage. Subtract the result from 1. Divide the tax-free bond's annual yield by the result of step two. The answer represents the yield a taxable bond would need to offer to equal that of a tax-free bond that is not subject to federal, state, or local taxes.
As always, if you have any questions or concerns, please reach out to the First Bank Wealth Management Team.
Most municipal bonds and short-term notes are issued in denominations of $5,000 or multiples of $5,000. Bond interest typically is paid every six months (though some types of bonds work differently); interest on notes is usually paid at maturity.
Municipal bonds are subject to the uncertainties associated with any fixed income security, including interest rate risk, credit risk, and reinvestment risk. However, the tax advantages associated with munis and their potential ability to provide an ongoing income stream have traditionally made munis an important part of a portfolio.
Why invest in munis?
During and after tax season, you may be thinking of ways to reduce your tax burden for 2024. Municipal bonds have historically appealed to investors in higher tax brackets. Unlike interest on corporate bonds, the interest from municipal bonds is usually (but not always) tax exempt on your federal income tax return. Because of their favorable tax treatment, tax-exempt bonds typically have a coupon rate that is lower than that of a corporate debt instrument with an identical maturity period.Also, municipal bond interest from a given state typically isn't taxed by governmental bodies within that state, though state and local governments typically do tax munis from other states. However, regulations vary from state to state.
Some states tax both in-state and out-of-state munis, and some tax neither. Consult a tax professional before investing to make sure you understand how your state treats municipal bonds.
Find out more about prudent tax planning strategies.
The tax advantages of municipal bonds mean that even though a muni's coupon rate may be lower than that of a taxable bond, its after-tax yield could be higher, depending on your tax bracket. Generally, the higher your tax bracket, the higher a muni's tax-equivalent yield will be.
Think about what you keep:
To accurately compare a tax-free bond to a taxable bond, you'll need to look at its tax-equivalent yield. To do that, you apply a simple formula that involves your federal marginal tax rate–the income tax rate you pay on the last dollar of your yearly income–and any state and local taxes.
To calculate the yield a taxable bond needs to equal that of a tax-free bond, use the following formula: Add your state and local tax rate to your federal tax percentage. Subtract the result from 1. Divide the tax-free bond's annual yield by the result of step two. The answer represents the yield a taxable bond would need to offer to equal that of a tax-free bond that is not subject to federal, state, or local taxes.
As always, if you have any questions or concerns, please reach out to the First Bank Wealth Management Team.
| Jason Mattingly, CFA, is a Portfolio Manager for First Bank Wealth Management. Possessing nearly 13 years of experience in financial services and a deep knowledge of investment management, you may contact Jason Mattingly at (314) 889-1028 or via email at [email protected]. |
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Broadridge Investor Communication Solutions, Inc. does not provide investment, tax, legal, or retirement advice or recommendations. The information presented here is not specific to any individual's personal circumstances. To the extent that this material concerns tax matters, it is not intended or written to be used, and cannot be used, by a taxpayer for the purpose of avoiding penalties that may be imposed by law. Each taxpayer should seek independent advice from a tax professional based on his or her individual circumstances. These materials are provided for general information and educational purposes based upon publicly available information from sources believed to be reliable — we cannot assure the accuracy or completeness of these materials. The information in these materials may change at any time and without notice. Prepared by Broadridge Advisor Solutions Copyright 2024.
Investment and insurance products are offered through OSAIC INSTITUTIONS, INC., Member FINRA/SIPC. Osaic Institutions and First Bank are not affiliated. Osaic Institutions does insurance business in California as Osaic Institutions Insurance Agency, CA Agency License #OH30186. Products and investment advisory services made available through Osaic Institutions are not insured by the FDIC or any other agency of the United States and are not deposits or obligations of nor guaranteed or insured by any bank or bank affiliate. These products are subject to investment risk, including the possible loss of value. First Bank Wealth Management is a trade name of First Bank, and certain products and services are provided through First Bank, and its affiliates and subsidiaries. Neither Osaic Institutions or First Bank, nor any of their affiliates or financial advisors, provide legal, tax, or accounting advice. You should consult your legal and/or tax advisors before making any financial decisions. Use FINRA’s BrokerCheck to learn about the professional background, certifications, licenses, and any regulatory violations or complaints for any financial advisor.
Investment and insurance products are offered through OSAIC INSTITUTIONS, INC., Member FINRA/SIPC. Osaic Institutions and First Bank are not affiliated. Osaic Institutions does insurance business in California as Osaic Institutions Insurance Agency, CA Agency License #OH30186. Products and investment advisory services made available through Osaic Institutions are not insured by the FDIC or any other agency of the United States and are not deposits or obligations of nor guaranteed or insured by any bank or bank affiliate. These products are subject to investment risk, including the possible loss of value. First Bank Wealth Management is a trade name of First Bank, and certain products and services are provided through First Bank, and its affiliates and subsidiaries. Neither Osaic Institutions or First Bank, nor any of their affiliates or financial advisors, provide legal, tax, or accounting advice. You should consult your legal and/or tax advisors before making any financial decisions. Use FINRA’s BrokerCheck to learn about the professional background, certifications, licenses, and any regulatory violations or complaints for any financial advisor.