6 Popular Tax Free Bonds

Reviewed: November 14, 2014
By FinanceWeb

Fully Insured Municipal Bonds

With the low rate of default among municipal bond issuers, one wonders of the advantages of insured municipal bonds. The difference is in the rating, particularly with small issuers. Insured bonds can carry AA or AAA ratings, and this makes the bond more marketable and more valuable on the secondary markets. Holders of insured bonds have a double layer of protection for income streams. The costs of bond insurance and the reliability of the issuers are factors as are the terms of the insured conditions. Insured municipal bonds offer tax-free benefits and a reinforced level of guaranteed payments.

Mutual Municipal Bond Funds

Income tax exemptions apply to mutual funds comprised of municipal bonds. Unlike buying bonds, the mutual funds do not provide certainty about income payments, and they are subject to distributions that can trigger alternative tax liability. Another factor is management expense. However, there are popular investments in short, intermediate, and long-term bond funds with impressive yields and very reasonable management fees.

Some Popular Tax Free Bond Funds

Among the best rated municipal bond funds are the T. Rowe Price Tax-Free High Yield Fund, and the American High-Income Municipal Bond Fund . Each offers yields in excess of 12 percent, and management expenses in the range of 0.7 percent. The T. Rowe Price Summit Municipal Income Fund, the Vanguard Long-Term Tax-Exempt Fund, and the T. Rowe Price Tax-Free Income Fund each yield above nine percent with expense ratios of 0.52 percent or less. The leading performers among short term and medium term tax-free municipal funds offer impressive results. Among short-term investments, the Oppenheimer Rochester Limited Term California Municipal Fund offers a yield above six percent with an expense ratio under 0.70 percent. Medium term leaders include the USAA Virginia Bond Fund with a nine percent performance and an expense ratio under 0.70 percent. These issues compare well with longer termed municipal securities.

General Obligation Municipal Bonds

General obligation bonds carry the full faith, credit, and taxing power of the state. These are quite unlikely to fall into default. Some states such as New York and California make extensive use of general obligation bonds. These issuers develop followings among seasoned investors. Long-term bonds from respected issuers can be quite profitable if held to maturity, and easily marketable in the secondary markets.

Municipal Revenue Bonds

Municipal revenue bonds are slightly riskier than general obligation bonds. The additional risk comes from conditional revenues. Items such as tolls and fees are subject to fluctuation. For example, a major storm that shuts down construction or damages bridges or highways can effectively reduce revenues from a bond-financed bridge or highway project. Revenue bonds have particular sources of income to repay principal and pay interest. Some revenue bonds relate to private activity that has a strong public benefit. In these cases, the income tax exemption will apply because of the public benefits. However, in some private activity cases, the alternative minimum tax can apply to high-income individuals and organizations.

Relief from State Taxes

Many federal government bonds are not taxable at the state level. These include major government corporations for education finance and housing finance. In states like New York and California in which there are significant state and city or county taxes, these state exemptions provide significant levels of relief.