Earn Tax-Free Dough While Supporting Your Team (or Local Government)
The NFL off-season is ending and there is a lot of discussion around building new stadiums and moving teams to other cities. Have you ever wondered how these stadiums are funded? If your guess is, “out of the pockets of the billionaire owners”, sorry, guess again! Enter Municipal Bonds.
What are Municipal (Muni) Bonds?
You already know that a bond is a debt instrument issued by an entity (corporation or government) to the bondholder (Investor). A municipal bond is a type of bond issued by a local or state government. These bonds are used to fund various civic projects such as roads, schools, and even sports stadiums.
One of the advantages of bonds over stocks is the reduced risk of losing your investment. A bond has a face value, an interest rate, and a maturity date. At the maturity date, the face value is returned to the bondholder with any accumulated interest (if interest payments were not paid at regular intervals before the bond matured). Any interest payments received from a bond is income and is therefore taxable.
Municipal bonds, in addition to the reduced risk that all bonds share, have two additional advantages: They offer further risk reduction because they are government issued and less likely to default on payments, and the interest payments are tax-free (different states and municipalities have different rules. Be sure to check before investing).
Where can you purchase Muni Bonds?
Financial Advisor: Most Muni bonds are traded through financial advisors and, like other bonds, they are usually sold in $1000 increments.
Online Brokerage Firm: There are some brokerage firms, such as Fidelity Investments, that offer bonds for purchase on their websites.
Mutual Funds: One of the easiest ways to invest in muni bonds is through a municipal bond fund or a tax-free bond fund. The same caveat of investing in mutual funds applies here: beware of fees and other costs!
Are All Muni Bonds Tax-Free?
The simple answer is NO. Most muni bonds are tax-free, however, there are some muni bonds that are only tax-free at the local and state levels, but not at the federal level. These taxable muni bonds are issued for projects that do not have a clear public benefit; for example, a sports stadium would likely be funded with a taxable muni bond. Taxable muni bonds tend to carry a higher interest rate to make them attractive to investors.
A Final Word
When pursuing a tax strategy for your investments, whether by investing in muni bonds or by opening a ROTH account, it is important to look at your investment portfolio as a whole. For example, it would not be advantageous to buy muni bonds in a ROTH account, which itself already grows tax-free. The reduced risk offered by muni bonds comes at the expense of lower interest rates, so it is important to fully capitalize on its advantages.
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