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You
made it through another tax season. If
you got a refund, you might be pretty
satisfied with how things turned out.
But if you would like to see a somewhat
different outcome in 2008, you may want
to review all areas of your tax return,
including your investment-related taxes.
As you may know, some investments are
more tax-friendly than others, and
municipal bonds might be some of the
friendliest ones of all.
If you are not that familiar
with municipal bonds, here are the
basics: Municipal bonds, or "munis," are
issued in two main categories: general
obligation bonds and revenue bonds.
General obligation bonds finance the
activities of state and local
governments, while revenue bonds pay for
specific projects, such as airports,
hospitals and other civic institutions.
When you purchase a muni,
you are supporting a project or a
service, possibly in your state or
community. And you will be rewarded for
your civic-mindedness through tax
breaks. Specifically, your interest
payments will be free from federal
taxes; if the municipality that issues
the bond is in your state, your interest
payments also may be exempt from state
and local taxes.
Municipal bond interest is
free from federal taxes, but some munis
– particularly airport and housing bonds
– might be subject to the alternative
minimum tax (AMT). If you think you may
have to pay the AMT – and a lot more
people are subject to this tax now than
in years past – you might want to avoid
these types of bonds. Conversely, if you
know you will not be assessed the AMT
even if you bought some AMT-subject
munis, you might be especially
interested in these bonds, because their
yields are typically higher than the
yields on regular municipal bonds.
In any case, municipal bonds
offer some benefits beyond tax-free
interest. For one thing, munis can help
you diversify a portfolio heavily
weighted with stocks. Municipal bonds
may not be affected by many of the
factors, such as poor corporate earnings
reports, that cause volatility in the
price of stocks. So, municipal bond
prices generally do not move together
with stock prices.
Furthermore, municipal bonds
are among the most secure investments
you can own. The default rate on munis,
especially general obligation bonds, is
typically quite low.
Which types of municipal
bonds are right for you? Your choice
depends, to a great extent, on your
goals and investment personality. For
example, longer-term munis that mature
in 10 years or more will generally pay a
higher interest rate than shorter-term
bonds. Yet, prices of the longer-term
offerings also may fluctuate more.
You may want to consider
owning a variety of short-,
intermediate- and long-term munis. This
type of portfolio, known as a bond
ladder, can help you in all types of
interest-rate environments. When market
rates are down, you benefit by owning
long-term bonds, which generally pay
higher rates than short-term bonds. But
if market rates are up, you can use the
proceeds of your maturing short-term
bonds to reinvest in issues with higher
rates.
Finally, when shopping for
municipal bonds, look for quality, those
bonds that are rated at least A or
higher by the major rating agencies.
Municipal bonds occupy their
own special niche in the investment
world - and it's a niche that you may
want to explore further. |
