Municipal bonds, also known as munis, are issued by a variety of government bodies including states, counties, and municipalities. The income from these bond funds is usually tax-free at the federal level, and the interest is tax-free at the state level if the bonds are issued in your state. This means that municipal bond investors are exempt from paying taxes on their earnings. Compared to comparable corporate and government bonds, these tax-free bond funds frequently pay greater relative interest payments. A tax-equivalent yield calculator can be used to compare the tax equivalent yield of a corporate or government bond to that of a municipal bond. To achieve the same take-home income as a 3 percent municipal bond, an investor in the 24 percent federal tax bracket would require a roughly 4% yield in a typically taxed bond. Here are seven municipal bond funds that can help you avoid paying taxes while also increasing your income.
Is it wise to invest in tax-free bonds?
Municipal bonds are an excellent method to keep your money safe while earning interest. The majority of them are tax-free at the federal level, and several are also tax-free at the state and local levels. Munis are frequently treated as a unique asset class, therefore understanding the fundamentals of muni bonds is essential.
What is the typical return on tax-exempt municipal bonds?
The top five municipal bond funds are ranked by their one-year trailing total return (TTM) as of the market close on December 10, 2021. The funds were chosen from a collection of funds that are open to new investors, need a $1,000 minimum initial investment, and have at least $50 million in assets under management (AUM). The first four funds are all Morningstar-rated “Over the last year, the “High Yield Muni” category has averaged a total return of 6.0 percent. The last fund is owned by the “Muni National Intermediate” with a total return of 1.9 percent throughout the same time period.
Which bonds are exempt from taxes?
Federal income from state, city, and local government bonds (municipal bonds, or munis) is normally tax-free. However, you must record this income when you file your taxes.
In most cases, municipal bond income is tax-free in the state where the bond was issued. However, take in mind the following:
- Occasionally, a state that normally taxes municipal bond interest would exempt special bonds when they are issued.
Municipal bond income may potentially be free from local taxes, depending on your state’s regulations. For further information on the rules in your state, see a tax advisor.
Is bond investing a wise idea in 2021?
Because the Federal Reserve reduced interest rates in reaction to the 2020 economic crisis and the following recession, bond interest rates were extremely low in 2021. If investors expect interest rates will climb in the next several years, they may choose to invest in bonds with short maturities.
A two-year Treasury bill, for example, pays a set interest rate and returns the principle invested in two years. If interest rates rise in 2023, the investor could reinvest the principle in a higher-rate bond at that time. If the same investor bought a 10-year Treasury note in 2021 and interest rates rose in the following years, the investor would miss out on the higher interest rates since they would be trapped with the lower-rate Treasury note. Investors can always sell a Treasury bond before it matures; however, there may be a gain or loss, meaning you may not receive your entire initial investment back.
Also, think about your risk tolerance. Investors frequently purchase Treasury bonds, notes, and shorter-term Treasury bills for their safety. If you believe that the broader markets are too hazardous and that your goal is to safeguard your wealth, despite the current low interest rates, you can choose a Treasury security. Treasury yields have been declining for several months, as shown in the graph below.
Bond investments, despite their low returns, can provide stability in the face of a turbulent equity portfolio. Whether or not you should buy a Treasury security is primarily determined by your risk appetite, time horizon, and financial objectives. When deciding whether to buy a bond or other investments, please seek the advice of a financial counselor or financial planner.
How do I go about purchasing tax-free bonds?
These tax-free bonds are available in both physical and demat form to investors. The subscription period for tax-free bonds is open for a limited time, and you must purchase these bonds within that time frame. If the bonds are purchased in tangible form, the investor must provide his or her Permanent Account Number (PAN).
Is it wise to invest in municipal bonds in 2022?
The key drivers of the municipal market are all positive, therefore 2022 is expected to see ongoing robust demand for municipal bonds. Taxes are first and foremost. Investors are still concerned about increasing taxes and will do everything possible to avoid them, keeping demand high.
Debt Mutual Funds
Debt mutual funds put their money into less risky investments like corporate bonds, government securities, and money market instruments. Because they invest in high-rated fixed income assets, they are believed to be safer than other mutual funds. These funds, however, are sometimes subject to depreciation and appreciation.
Despite this, debt funds can give significantly larger returns than fixed deposits. They are extremely liquid and might be a good substitute for fixed deposits.
Liquid Funds
Liquid funds are debt funds that solely invest in high-rated money market instruments with a 91-day maturity. Liquid funds have the most significant advantage in that they give liquidity, which fixed deposits do not. As a result, you can utilize liquid funds not just as a substitute for fixed deposits, but also to build up an emergency reserve to fall back on in times of need. Because they invest in high-quality securities, liquid funds are the most secure mutual funds.
Equity Funds
These are mutual funds that excel in outperforming inflation. It necessitates the use of a portfolio manager to invest an investor’s cash in equities, such as common stocks of publicly listed corporations, in order to gain ownership of a business. They are a fantastic alternative to long-term fixed deposits, with returns that are often higher than fixed deposits. When it comes to long-term investments, equity funds have a lower risk level.
Corporate Fixed Deposits
Investors who are willing to take a bit more risk might choose for corporate fixed deposit options, which are nothing more than corporate FDs. A corporate FD has substantially greater interest rates than a bank FD with variable tenure possibilities. The disadvantage of this type of investment is that it is not as safe as bank fixed deposits, thus investors should only invest in well-established businesses.
Fixed Maturity Plans
Plans with a set maturity date Invest in debt instruments and securities with maturities that are close together. For example, if a fixed maturity plan has a one-year maturity period, it will invest in bonds, securities, and other comparable options with shorter maturities. Early withdrawal is not possible, and the fund can only be accessed when it reaches maturity. As a result, it is prudent to exercise caution while considering this option because your money will be locked in until maturity.
Fixed maturity plans are a great alternative to a fixed deposit, but they aren’t as liquid as a fixed deposit. On the plus side, the risks involved with investing in these are extremely low, and they provide a far larger return.
Government Bonds
Even though the yields offered by government bonds are just marginally greater than a fixed deposit, they are perhaps the most well-known alternative to fixed deposits in India. These financial products have a longer lock-in period, but they allow investors to diversify their portfolio.