When do you buy municipal bonds

An investor buying a muni bond is funding that particular project over a set period of time. They expect to receive interest or coupon payments usually semiannually and the initial principal back when the bond matures, or when the loan term ends. There are two main types of muni bonds, and they differ by where they get the money to pay investors.

A general obligation bond, or GO bond, is typically backed by a municipality's local government, with an unconditional promise of repayment. It might pay its investors from a general fund or through a dedicated local tax. A revenue bond uses the money generated by the project to fulfill its debt obligations.

Examples include a bridge or tunnel that collects tolls or a stadium using ticket sales to pay interest and principal back to investors. Sometimes a municipality issues a revenue bond on behalf of a private entity, such as a university, housing developers or health systems. These are called conduit bonds. In these cases, the conduit borrower has the ultimate responsibility of covering the debt obligations.

Check out the best online brokers. Limited time offer. Terms apply. As with any investment, it's important to weigh the pros and cons of municipal bonds before jumping in. Tax minimization: Many municipal bonds are exempt from federal taxes, and if the investor lives in the same state where the bond is issued, the muni will often be exempt from state and local taxes as well.

Here's how that calculation works:. An investor would need to find a taxable bond yielding 6. Being thoughtful about where they purchase tax-free muni bonds can save investors money. For example, many investors in higher tax brackets strategically buy tax-exempt munis in their brokerage accounts, which are taxable.

For instance, a portion of the income you receive may be subject to the federal alternative minimum tax, even if that income is classified as tax free. Also, if you sell a municipal bond, the proceeds from that sale may be subject to capital gains or other types of taxes. De Minimis Tax Risk If you purchase a municipal bond in the secondary market at a market discount to the revised issue price, you will have to pay tax on the difference when the bond is redeemed.

The revised issue price is par for a bond originally issued at a price greater than or equal to par. For a bond issued below par an original issue discount bond , the revised issue price will be the original price plus the accredited discount. This market discount can be taxed as either a capital gain or ordinary income. Capital gains are taxed at the current capital gains tax rate and ordinary income is taxed at your marginal tax rate, which can be close to twice as high as the capital gains rate for a taxpayer in the highest federal tax bracket.

The De Minimis rule states that if the market discount revised issue price less the purchase price is less than 0. If the market discount is above the De Minimis threshold, it will be taxed at your ordinary income tax rate. Example: If you are looking at a 20 year municipal bond with a revised issue price of 99 and nine complete years left until maturity, the de minimis discount is 0.

You then subtract the 2. This is the lowest price the bond can be purchased for in order for the market discount to be treated as a capital gain. If the price of the discount bond is purchased at a price below So, if you purchased this bond for Finally, it's important to remember that tax laws may change. The favorable tax conditions that existed at the time you purchased a bond may either have been phased out or no longer available to investors in your tax bracket.

Please consult your tax advisor before purchasing any security. Inflation risk As with all bonds, investors run the risk that inflation will diminish the purchasing power of a municipal bond's principal and interest income.

Repudiation risk There can be no assurance that bonds validly issued will not be partially or totally repudiated by the issuing state or municipality, should that be deemed reasonable and necessary to serve other important public purposes. Other risks Not all risks can be quantified in a bond's prospectus or offering circular. Why bother with bonds? See all Viewpoints articles. Subscribe to Fidelity Viewpoints Weekly Edition.

Fidelity Learning Center. Fidelity does not provide legal or tax advice. The information herein is general and educational in nature and should not be considered legal or tax advice.

Tax laws and regulations are complex and subject to change, which can materially impact investment results. Fidelity cannot guarantee that the information herein is accurate, complete, or timely.

Fidelity makes no warranties with regard to such information or results obtained by its use, and disclaims any liability arising out of your use of, or any tax position taken in reliance on, such information. Consult an attorney or tax professional regarding your specific situation. Fixed Income Glossary. It is also a list of the maturity dates on which individual bonds issued as part of a new issue municipal bond offering will mature.

Skip to Main Content. Search fidelity. Inflation risk. Inflation is a general upward movement in prices. Inflation reduces purchasing power, which is a risk for investors receiving a fixed rate of interest.

It also can lead to higher interest rates and, in turn, lower market value for existing bonds. Liquidity risk. Many investors buy municipal bonds to hold them rather than to trade them, so the market for a particular bond may not be especially liquid and quoted prices for the same bond may differ.

Tax implications. Consider consulting a tax professional to discuss the bond's tax implications, including the possibility that your bond may be subject to the federal alternative minimum tax or eligible for state income tax benefits. Broker compensation.

Most brokers are compensated through a markup over the cost of the bond to the firm. This markup might be disclosed on your confirmation statement. If a commission is charged, it will be reported on your confirmation statement. You should ask your broker about markups and commissions. If you have to sell a bond in the future, you may have to sell it below redemption value to compensate for the lower yield if rates go up.

There are three major ratings agencies that rank bond issuers based on their likelihood of meeting their financial obligations versus defaulting on them. Generally, the higher an issuer's credit rating, the lower the interest rate its bonds pay. Conversely, issuers with a lower rating generally must offer higher interest rates to offset their associated risk.

But remember that bond ratings can change. Just because an issuer starts out with a strong rating doesn't mean it can't get downgraded if its financial circumstances change. Muni bonds have a high rate of recovery even when they default, but your capital can be tied up longer than the term of the bond, and investors rarely recoup interest not paid.

So be sure to consider all the implications when considering which municipal bonds to buy. Municipal bonds differ from corporate bonds in the tax treatment of the interest they pay, and they also have lower default rates. This is why municipal bonds generally pay lower yields than similar corporate bonds.

In short, the risk-reward profile for munis and corporate bonds is different. If less risk is your priority, munis come out ahead; if better yields with higher risk suits you, corporate bonds get the nod.

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