Spain occupied Puerto Rico beginning in 1493, when Christopher Columbus arrived on the island. Puerto Rico was ceded to the United States after the end of the SpanishAmerican War in 1898. The US then refused to pay the colony’s creditors, claiming they were owed a dreadful amount.
Before 1898, the people of Puerto Rico had Spanish citizenship; after 1898, the people of Puerto Rico did not have either independent nor colonial citizenship. President William McKinley signed the Foraker Act in April 1900, allowing only the House of Representatives of Puerto Rico to be elected by popular vote. Puerto Rico was characterized as an unincorporated “territory appurtenant and belonging to the United States, but not a part of the United States under the revenue clauses of the Constitution” in the Insular Cases, a series of Supreme Court decisions from the early 1900s.
Although legally defined as a commonwealth or protectorate, Juan R. Torruella considered Puerto Rico’s relationship with the United States to be colonial because the US Federal Government has ultimate economic and political decision-making authority and Puerto Rican citizens do not have full constitutional rights. Puerto Rico is subject to US legislation due to its political position. One of these laws is the Jones-Shafroth Act, which exempts interest payments from bonds issued by the government of Puerto Rico and its subdivisions from federal, state, and municipal income taxes (the so-called “triple tax exemption”), regardless of the bondholder’s location. Puerto Rican bonds were appealing to municipal bond investors because of this right. This characteristic prompted Puerto Rico to issue bonds that were always attractive to municipal investors, regardless of Puerto Rico’s account balances. As a result, Puerto Rico began issuing debt to cover its expenses, a practice that it has continued since 1973. The island also started issuing debt to pay off earlier debt, as well as refinancing older debt with low interest rates with debt with higher interest rates.
Puerto Rico was officially prohibited from declaring bankruptcy under Chapter 9 of Title 11 of the United States Code by Congress in 1984. Congress withdrew the tax credits between 1996 and 2006, resulting in the loss of 80,000 employment on the island and caused its population to drop and economy to contract in all but one year since the Great Recession began. Because Puerto Rico’s constitution stipulates that “all available resources” must first be used to pay the Commonwealth’s general obligation bonds, the Commonwealth began issuing Puerto Rico Sales Tax Revenue Bonds in 2006 to circumvent the constitution’s restrictions by being paid directly into a separate urgent interest fund. The sales tax has been raised to 11%. In 1958, the last property tax assessment was completed. Between February 4 and 11, 2014, three bond credit rating agencies downgraded Puerto Rico’s bonds to non-investment grade (commonly known as “junk status” or speculative-grade) when the island’s outstanding debt reached $71 billion, roughly equal to 68 percent of GDP. Bond acceleration clauses were activated as a result of the downgrading, requiring Puerto Rico to repay some debt instruments in months rather than years. Investors were fearful that Puerto Rico might default on its debt at some point. Puerto Rico’s ability to issue bonds in the future would be harmed if it defaulted. Puerto Rico now claims that it will be unable to maintain current operations unless dramatic actions are taken, which could result in public upheaval. Protests against the austerity measures have already taken place. Puerto Rico’s present debt problem is the result of these events, as well as a succession of governmental financial deficits and a recession.
Are municipal bonds in Puerto Rico tax-free?
All bonds issued by the Government of Puerto Rico, or by its authority, are exempt from taxation by the United States, the Government of Puerto Rico, or any political or municipal subdivision thereof, or any State, Territory, or possession, or any county, municipality, or other municipal subdivision of any State, Territory, or possession of the United States, or the District of Columbia.
Can your bonds be taken by the government?
Savings bonds are a concept you may recall from a simpler time in your life. Boards made of chalk. Text books. Teenagers. Yes, we’re talking about history class in high school. Savings bonds were very popular in the United States during the twentieth century, and they are still utilized today. Before we look at whether savings bonds are good for you, let’s review our history of the United States.
Heading back to history class
Franklin D. Roosevelt first signed the Savings Bond Act into law to help Americans save money during the Great Depression. People loved saving bonds because they were a safe long-term investment throughout the economic downturn. People knew they wouldn’t lose money if the economy tanked since they were backed by the US government’s full faith and credit.
When you buy a savings bond, you are effectively lending money to an entity, such as the United States government. The government commits to pay you back later with interest, just like an IOU. Savings bonds were a successful means for the government to raise cash during World War II, and households preferred to acquire them to pay for higher education in the 1960s and 1970s. When Congress introduced tax deductions for bonds used to pay for tuition in the 1990s, they became even more popular.
Savings bonds today
Savings bonds work in a similar way these days. You continue to make a low-risk loan to the government. However, instead of paper certificates that you can hide beneath your bed, bonds are now primarily marketed online through TreasuryDirect.gov. Â
Bonds continue to be a secure and simple way to save and earn money over time. Not only will the Treasury repay you, but it will also quadruple your initial investment over the next 20 years. Assume you acquired a $10,000 bond in 2020. Because of the government’s compounding interest payments, your bond will be worth at least $20,000 by 2040. You can then continue to earn interest for another ten years. Plus, there’s a bonus! When you redeem your bond, you won’t have to pay any state or local taxes on the money. If you use your bond to pay higher education at a qualifying institution, you may be eligible for federal tax benefits.
Types of bonds
Series EE bonds and Series I bonds are the two categories of bonds available.
Both generate income on a monthly basis and can be purchased online for any amount between $25 and $10,000. The Series EE bond, on the other hand, has a fixed rate component whereas the Series I bond has both a fixed and variable rate component. With the Series I, your profits will change based on inflation.
Do bonds make sense for you?
What makes savings bonds different from other types of savings vehicles? Are they, more crucially, the best fit for your requirements? Traditional savings and money market accounts allow you to earn interest while having immediate access to your funds. Bonds, on the other hand, appreciate slowly and are most valuable after 20 to 30 years.
If you’re looking for a long-term investment, consider savings bonds. You can save money and earn interest while resisting the need to withdraw money. But don’t go out and buy a bond right away. There are numerous long-term saving vehicles available today, each with its own set of benefits and drawbacks. Roth IRA and 529 accounts are popular options to consider whether you’re saving for education or retirement. They may also provide better tax advantages or a higher Annual Percentage Yield (APY) than savings bonds.
Is it possible to lose money on municipal bonds?
These funds have a low risk of losing value, and the interest they pay is consistent. They also pay a very low interest rate as a result of their safety. Risk and reward are inextricably linked: a lesser risk equals a lower payoff.
In 2020, are municipal bonds a decent investment?
- Municipal bond interest is tax-free in the United States, however there may be state or local taxes, or both.
- Be aware that if you receive Social Security, your bond interest will be recognized as income when determining your Social Security taxable amount. This could result in you owing more money.
- Municipal bond interest rates are often lower than corporate bond interest rates. You must decide which deal offers the best genuine return.
- On the bright side, compared to practically any other investment, highly-rated municipal bonds are often relatively safe. The default rate is quite low.
- Interest rate risk exists with any bond. You’ll be stuck with a poor performer if your money is locked up for 10 or 20 years and interest rates rise.
Are municipal bonds inherently more secure than corporate debts?
When deciding whether to purchase corporate or municipal bonds, there are a number of considerations to consider. The quality of the corporation issuing the bond, the tax consequences, yield, liquidity, and how the money earned through the issuance of the bond will be used are some of the most important of these variables.
Quality of Issuer
The issuer’s quality is one of the first things you should look into before buying a bond or any other financial instrument. Bond issuers will have varying credit ratings, which means that investing in the securities they’ve made accessible exposes you to credit risk.
Bond issuer credit ratings are provided by two agencies: Moody’s and Standard & Poor’s. The rating scale used by Moody’s spans from C to AAA, with AAA being the highest attainable grade. Standard & Poor’s has a rating system that ranges from D to AAA, with AAA being the highest attainable rating.
Higher ratings indicate that the bond’s issuer is less likely to default. After all, individuals who invest in the security stand to lose if the corporation that issued it fails to meet its obligations.
Corporate Bonds Come With Higher Default Rates
Corporations issue corporate bonds, and each corporation is distinct. Some people make more money than others, some have superior management teams, and some will continuously fulfill their duties while others will fail.
Instruments issued by corporations have a higher default risk than municipal bonds, therefore it’s very crucial to pay attention to how rating agencies grade the bond before you invest.
The good news is that even businesses rarely go bankrupt. Only approximately 0.13 percent of companies that issue bonds default, according to the Corporate Finance Institute.
Tax Implications
You must pay taxes on all income you earn, whether it is from a side hustle, your day job, or investment returns. However, not all forms of income are taxed in the same way. When determining whether to invest in corporate or municipal bonds, consider the following tax effects.
How Corporate Bonds Are Taxed
Corporation-issued bonds are sometimes referred to as taxable bonds since the revenues earned from these investments are subject to both federal and state income taxes at the general income tax rate. Your tax bracket determines the exact rate you’ll pay on your returns.
How Municipal Bonds Are Taxed
Gains from municipal bond investments are always tax-free on the federal level and are frequently tax-free on the state level as well. The tax exemption is effectively a “thank you” from both the federal and local governments for investing in projects that benefit your community with your money.
While munis are immune from state and local taxes in the vast majority of circumstances, this is not always the case. If you buy a municipal bond from a municipality other than the one where you live, for example, your local authorities may choose to tax the bond’s returns at the usual local income tax rate.
For example, if you live in New York City and invest in a municipal bond issued by a government body in Florida, New York City may charge you its standard local tax rate on the investment’s profits.
Yields
Bond yields fluctuate dramatically based on the credit of the issuing institution, the maturity period of the bond, and other considerations.
Generally speaking, here’s how yields differ between corporate and municipal bonds:
Corporate Bonds Generally Have Higher Yields
Local governments are well-respected institutions with a track record of good financial management. Corporations, on the other hand, will have a wide range of financial strength and creditworthiness.
Corporate bonds have higher interest rates than government bonds because companies are typically less creditworthy than governments. After all, if corporate bond yields were the same as government bond yields, no one would lend to riskier businesses. Who wants to buy a corporate bond when you may get the same returns by investing in lower-risk municipal bonds?
Munis Provide Small Gains
Bonds issued by the government have a lower risk of default, making them a safer option for investors. When it comes to investing, however, safer options tend to yield lesser returns, and municipal bonds are no exception.
These bonds’ pricing takes into account the extremely minimal default risk, resulting in lower interest rates, smaller interest payments, and poorer overall returns.
That is, until you account for taxes. A high-income earner, for example, may discover that municipal bonds are a better fit because they are tax-free on both the state and federal level. For an investor in the highest tax bracket, however, much of the profit on corporate bonds would be wiped out by taxes.
Liquidity
Whether investing in bonds or any other asset, investors should constantly consider liquidity. The ease or difficulty of changing an investment back into cash, if desired, is referred to as liquidity.
Bonds with low liquidity will be difficult to convert into cash before their maturity dates, whereas bonds with high liquidity will be easy to dump and change into spendable money on demand.
Corporate Bonds Are Often Less Liquid
While any type of bond can be sold on the secondary market, there must be a buyer for the bond to be sold. In some situations, investments in high-risk bonds and other bonds issued by corporations may become illiquid if no other investors are interested in purchasing them.
Furthermore, when the economy and markets are doing well, bond liquidity decreases. During bull markets, investors prefer not to want their money locked up in fixed-income assets, instead focused on the bigger potential for returns offered by equities.
Municipal Bonds Are Highly Liquid
The municipal bond market is quite active, and municipal bonds are often easier to sell than corporate bonds. Because muni bonds are issued by entities that are almost certain to meet their commitments while also delivering tax benefits, they are appealing investments for high-income individuals.
How Funds Are Used
Investors are becoming increasingly concerned with the way in which their assets are spent. In fact, there’s a whole industry devoted to social impact investing, which is investing in assets that use your money to help causes you care about.
So, when you invest in these two different sorts of bonds, how is your money spent?
How Corporations Use Money Raised Through Bond Sales
Corporations may need to raise capital for a variety of reasons. The following are a few of the most common:
- Working Capital is a term used to describe the amount of money Making money takes money, and maintaining a business can be a costly task. Corporations may need working capital for general purposes if their money is locked up in inventory, new equipment, and other assets required to keep them moving in the correct direction. Companies can issue bonds to raise cash for immediate operational requirements while pledging to repay investors later.
- Acquisitions. Companies frequently merge with one another, resulting in deals in which the total worth of all pieces exceeds the value of the original assets. Acquisitions, on the other hand, are a costly business, and companies frequently require additional capital to complete merger and acquisition deals.
- Research. Almost every publicly traded firm on the market today spends a significant amount of money on research and development. Corporations may issue bonds to fund this research in some instances.
How Municipalities Use Money Raised Through Bond Sales
The vast majority of government-issued bonds are used to fund public-sector initiatives.
When a major thoroughfare is riddled with potholes or your county’s library needs to be repaired, for example, governments frequently issue bonds to cover the costs of these projects. Governments can repay investors either through project revenue or tax revenue generated by the projects they fund.
What is the status of Puerto Rico bonds?
MIAMI, Florida On Tuesday, a federal judge approved Puerto Rico’s exit from bankruptcy under the largest public-sector debt restructuring plan in US history, nearly five years after the financially beleaguered territory claimed it couldn’t pay its creditors.
Hurricanes Irma and Maria, a series of earthquakes, and the coronavirus epidemic have only exacerbated Puerto Rico’s economic woes since it declared bankruptcy.
The restructuring proposal will cut the government of Puerto Rico’s debt, which totals $33 billion, by nearly 80%, to $7.4 billion. In addition, the agreement will save the government approximately $50 billion in debt payments.
Puerto Rico will also begin repaying creditors, albeit at a reduced rate, something it has not done in years. In 2015, the government announced that it would be unable to repay its debts.