The Corporate Executive's Guide to General Investing by Paul Mladjenovic

Author:Paul Mladjenovic
Language: eng
Format: epub
Publisher: Business Expert Press
Published: 2022-03-14T00:00:00+00:00

Municipal Bond Mutual Funds

As I mentioned earlier, municipal bonds deserve their own category and this does have several subcategories. When you consider municipal bonds you are thinking tax-free income and this general category is for those that are generally in a higher combined tax bracket. A higher combined tax bracket means the total tax rate you are paying for federal, state, and local taxes. Your tax adviser should be consulted regarding your personal tax situation and how beneficial tax-free income would be to you. Say, for example, you are a high-income taxpayer that resides in a high-tax state such as California and you were deciding between a corporate bond yielding 3 percent and a California municipal bond paying you 1.5 percent. If your combined tax rate is at 60 percent, that means you would net more income from the municipal bond. Why? Because if the pretax corporate interest income dollar amount was, say, $3,000 and the municipal was $1,500, then how much would you net? The municipal would be triple tax-exempt so the gross amount and the net amount would be the same at $1,500. Meanwhile, the $3,000 taxable corporate bond interest income would be taxed at 60 percent or $1,800 (yikes!), meaning you net only $1,200. In this example, the municipal bond would be a better deal.

Keep in mind that although municipal bond interest income is generally free from federal taxes and states do not tax their own municipal bonds, states can tax each other’s municipal bonds. This, in turn, stays true with municipal bond mutual funds. If you live in New York, for example, the interest from your New York municipal bond will likely be tax-free but if you live in New York and you have municipal bond interest income from another state (such as New Jersey or Ohio), then that interest may not be taxable in those states but will most likely be taxable in New York state. Again, check with your tax adviser for your personal situation.

Municipal bond subcategories. The three basic subcategories for you to choose from are:

• Aggressive municipal bond mutual fund. This offers higheryield, tax-free municipal bond income through lower-rated bonds (bond ratings rated B or lower). This is the riskiest subcategory.

• Investment-grade municipal bond mutual fund. As the name states, this fund invests in quality municipal bonds that are rated AAA, AA, or A. These are most suitable for retirees that are in higher combined tax brackets.

• Municipal tax-free money market mutual fund. This would actually be a subcategory in the money market primary category but I include it here as well. This fund maintains a portfolio of short-term money market instruments and is suitable for those that are in high tax brackets and need to park their cash in a liquid, safe, and accessible fund until they reinvest the funds in another vehicle or use the month otherwise.

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