Most municipal bonds are exempt from federal taxes on the interest they earn. Tax-free investments can make your portfolio more tax efficient, especially if you fall into a high tax bracket and if the current tax policies are changing for the worse. Municipal bonds can help you diversify your fixed income positions as well.
When you purchase a municipal bond, you're loaning money to a municipality, city, village, county, or state. Typically, the municipality borrows money to pay for infrastructure projects such as building or repairing roads or a community center. The municipality generally pays back the bonds with money made from those projects - by paying off a bridge bond with money that is raised from bridge tolls, for instance.
Most municipal bonds are exempt from federal taxes on the interest they earn. Additionally, if the bond is issued in the state that you live in, you may owe no state taxes either. However, interest on some municipal bonds, often called private activity bonds, can still fall into alternative minimum tax guidelines and to state and local taxes. Also, buying and selling municipal bonds can be subject to capital gains taxes.
Nevertheless, tax-free investments can make your portfolio more tax efficient, especially if you fall into a high tax bracket and if the current tax policies are changing for the worse. Municipal bonds can help you diversify your fixed income positions as well. Additionally, municipal bonds are generally considered low-risk adding steady income to your portfolio, thereby can be very attractive to risk-averse investors.
Tax-free vs. taxable bonds
Municipal bonds, because they are generally more conservative and because the income is protected from federal income taxes typically pay lower interest rates than comparable taxable bonds. If you fall into a higher tax bracket, then tax-free investments become more valuable to you.
To decide whether a tax-free bond is better than a taxable bond, convert the tax free yield into its taxable equivalent yield. The formula to accomplish this is simply: Tax-equivalent yield = Tax-free yield / (1- your federal tax bracket).
For example, let's say you want to get into a tax-free bond that pays 2%, and you're in the 28% federal income tax bracket. Further, assume you live in the state that issues the loan so there aren't any state or local taxes that apply to the municipal bond. For someone in your situation, the tax-free bond's equivalent taxable yield is 2 / (1 - 0.28). Your bond's tax-equivalent yield is 2.78%. That's potentially a good purchase if comparable taxable bonds are paying 2.5% but the arrangement might not be as lucrative if comparable taxable bonds are yielding 2.8%.
Let's look at another example. Say you and your spouse file jointly and report a net taxable income of $245,000 which makes you fall in the 33% federal income tax bracket in 2010. Assume that state and local taxes don't apply. Below is a small table that shows tax-free bond yields and their taxable equivalents.
In this situation the investor may consider purchasing a tax-free bond yielding 2.5% or a comparable taxable bond yielding 4%. In this scenario it would be wiser to buy the taxable bond, because the taxable bond's yield is greater than the tax-free bond's tax-equivalent yield of 3.73%. The table below shows possible tax-free bond yields and their taxable equivalents.
Municipal bond mutual funds
Municipal bond mutual funds offer greater portfolio diversification for investors that are not looking to dabble in individual bond purchases or want to buy into multiple municipal bonds.
The formula is the same as it is for a single bond. Say a taxable bond fund offers a yield of 3% while a tax free fund offers 2.5%. An individual that falls into the 28% tax bracket would find, using the previous formula, that the tax-free bond's tax-equivalent yield of 3.47% is more than the taxable bond's yield, making it a better decision to buy into the tax-free fund.
An Isakov Planning Group Financial Advisor can provide you with more information on municipal bonds and guide you on how to incorporate them into your overall portfolio that suits your investment goals.
ABOUT THE AUTHOR
Isakov Planning Group financial advisors bring industry leading resources and expertise to help clients pursue and achieve their goals. Along with expert market analysis from the firm's top investment managers, your Isakov Planning Group financial advisor will work with you to develop and deliver tailored solutions that can help you get on track and ultimately achieve your most important objectives, whether you're looking to plan for retirement, build tax-free wealth, get your kid's through college, or build a lasting legacy for your family. http://www.isakovgroup.com/
Thursday, August 16, 2018
Wednesday, July 25, 2018
Why Bonds are the Best Things Since Sliced Bread
We usually think that bonds are a limitation of our freedom. In this article I’ll show You why I think that bonds are mandatory to start building true and financial freedom.
My personal Inspiration
It happened quite a clash of opinions with a girl I know. The issue concerned the concept of "freedom". This girl, whose references are omitted for privacy, is a highly-trained scholar of theology with which I occasionally compare myself; I really love to talk to her about general topics, philosophy and how's life; I take very much into account his views, although we are often at odds, because thanks to his keen vision on the topics I always find great inspiration of thought and I can understand that, ultimately, our opinions are united by a deep thought and in relationship of cause and effect. I would then take advantage of her gift to explain why, in my opinion, the bonds between people are the basis of freedom.
According to her personal opinion, freedom is always subordinate to the bonds we create with people and that these bonds are limiting the choices we have and actions we can take. Obviously, as a supporter of the “pursuit of freedom”, how I could not be in the opposite position? Now, to her I only said that I was in disagreement, not because I did not give weight to the links between people, but simply because I believe that freedom has a higher priority.
Why bonds can bring freedom?
Once back home, I immersed myself in the thoughts, stimulated by this strange inspiration: the bonds.
The bonds are agreements between people, sometimes totally emotionally, but still ties. We have learned from my previous article that money is an agreement between people. The greater the number of agreements in our favor, the greater the number of people that we can influence simply because we share with them a particular point of view on the agreement, the greater the amount of money that we can convey to our pockets.
In this particular situation, by having a multitude of bonds, in fact, does not limit our freedom, but this increases it: the higher the number of bonds / agreements that we will create, the more links in our network of influence. Our network, however, won’t be a trap, but a real trampoline to jump higher and a safety net if we were to fall.
Banks are masters at creating more and more agreements and affect a growing number of people: that's why they get more and more money.
Is for this reason that I do not see bonds so limiting, but rather a stimulus and help in continuing to seek freedom.
By: Alessio V Magri
ABOUT THE AUTHOR
Bonds. Are they really a limitation? I have been inspired by a clash of opinions to take bonds and surpass limitations Find more resources on http://questmyself.com/ Visit my Blog Now!
My personal Inspiration
It happened quite a clash of opinions with a girl I know. The issue concerned the concept of "freedom". This girl, whose references are omitted for privacy, is a highly-trained scholar of theology with which I occasionally compare myself; I really love to talk to her about general topics, philosophy and how's life; I take very much into account his views, although we are often at odds, because thanks to his keen vision on the topics I always find great inspiration of thought and I can understand that, ultimately, our opinions are united by a deep thought and in relationship of cause and effect. I would then take advantage of her gift to explain why, in my opinion, the bonds between people are the basis of freedom.
According to her personal opinion, freedom is always subordinate to the bonds we create with people and that these bonds are limiting the choices we have and actions we can take. Obviously, as a supporter of the “pursuit of freedom”, how I could not be in the opposite position? Now, to her I only said that I was in disagreement, not because I did not give weight to the links between people, but simply because I believe that freedom has a higher priority.
Why bonds can bring freedom?
Once back home, I immersed myself in the thoughts, stimulated by this strange inspiration: the bonds.
The bonds are agreements between people, sometimes totally emotionally, but still ties. We have learned from my previous article that money is an agreement between people. The greater the number of agreements in our favor, the greater the number of people that we can influence simply because we share with them a particular point of view on the agreement, the greater the amount of money that we can convey to our pockets.
In this particular situation, by having a multitude of bonds, in fact, does not limit our freedom, but this increases it: the higher the number of bonds / agreements that we will create, the more links in our network of influence. Our network, however, won’t be a trap, but a real trampoline to jump higher and a safety net if we were to fall.
Banks are masters at creating more and more agreements and affect a growing number of people: that's why they get more and more money.
Is for this reason that I do not see bonds so limiting, but rather a stimulus and help in continuing to seek freedom.
By: Alessio V Magri
ABOUT THE AUTHOR
Bonds. Are they really a limitation? I have been inspired by a clash of opinions to take bonds and surpass limitations Find more resources on http://questmyself.com/ Visit my Blog Now!
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