Taxable Municipal Bonds
What Are Taxable Municipal Bonds?
While Most investors are familiar with Tax-Free municipal bonds, some may not be aware that some municipal bonds are issued as Taxable.
All Municipal bonds are debt obligations issued by states, cities, counties, and other governmental entities to raise money to build schools, highways, hospitals, and sewer systems, as well as many other projects for the public good.
When you purchase a municipal bond, you are lending money to an issuer who promises to pay you a specified amount of interest (usually paid semiannually) and return the principal to you on a specific maturity date.
When bonds are issued it is up to the issuer, based on IRS regulations to identify whether a bond’s interest income is taxable or tax-free. While tax-free municipal bonds are exempt from federal and in some cases state, and local income taxes, for taxable bonds there is no such exemption for federal income taxes but, based on the investor’s state of residence, there may be an exemption on state and local taxes.
Investing in taxable municipal bonds provides the potential for a regular stream of taxable income, and taxable bonds are suitable for many types of investment accounts including IRA and all qualified retirement plans.
Who Should Invest in Taxable Municipal Bonds?
Taxable Municipal Bond Features
- Potential Safety of Principal – When investing in municipal bonds, investors are paid back the full face value of their investment at maturity or earlier if called, unless the bond defaults. This is important because many investors, particularly those nearing retirement or in retirement, are concerned about protecting their principal. In July of 2021, Moody’s published research that showed that rated investment-grade municipal bonds had an average cumulative 10-year default rate of just 0.10% between 1970 and 2020.* That means while there is some risk of principal loss, investing in rated investment-grade municipal bonds can be an important part of your portfolio.
- Potential Regular Income – Municipal bonds typically pay interest every six months unless they get called or default. That means that you can count on a regular, predictable income stream. Because most bonds have call options, which means you get your principal back before the maturity date, subsequent municipal bonds you purchase can earn more or less interest than the called bond. According to Moody’s 2021 research,* default rates are historically low for the rated investment-grade bonds favored by Hennion & Walsh.
- Liquidity & Marketability – In the event you must sell before maturity, taxable municipal bonds can usually be sold on any business day at their current market value. This may be equal to more OR less than the amount originally invested.
- Call Protection – Municipal bonds usually provide protection for a specific period of time against redemption or being called prior to maturity.
- Minimum Purchase – You may typically invest in municipal bonds with a minimum purchase of $10,000 par value, and $5,000 increments thereafter.
Investing in bonds involves risk including possible loss of principal. Income may be subject to state, local or federal alternative minimum tax. When interest rates rise, bond prices fall, and when interest rates fall, bond prices rise. *Source: Moody’s Investor Service, July 9, 2021 “US Municipal Bond Defaults and Recoveries, 1970–2020. Past performance is not a guarantee of future results.