The simple answer to this question is “yes.” There are two main types of investments that pay interest tax-free — municipal bonds and municipal bond mutual funds. Municipal bonds are issued by state and local governments in order to finance capital expenditures. Typically, municipal bond funds invest in municipal bonds.
Municipal bonds are generally free of federal tax because the interest from bonds issued by a state, municipality, or other local entity is exempt from federal taxation. Investors may be subject to federal alternative minimum tax.
As an added benefit, most states will allow a state tax exemption if the owner of the bond resides in the state of issue. However, if you purchase a bond outside your area of residency, it may be subject to both state and local taxes.
If you buy shares of a municipal bond fund that invests in bonds issued by other states, you will have to pay income tax. In addition, while some municipal bonds that are in the fund may not be subject to ordinary income tax, they may be subject to federal, state, or local alternative minimum tax. If you sell a tax-exempt bond fund at a profit, there are capital gains taxes to consider. Bond funds are subject to the same inflation, interest-rate, and credit risks associated with their underlying bonds. As interest rates rise, bond prices typically fall, which can adversely affect a bond fund’s performance.
Municipal bonds come in a variety of forms and should be selected by strict criteria based predominantly on the state’s or municipality’s ability to service the debt. It’s important to remember that the principal value of bonds may fluctuate with market conditions. Bonds redeemed prior to maturity may be worth more or less than their original cost.
With today’s low interest rate environment likely to stay the same for a while, it may be to your benefit to look into the tax exempt status of municipal bonds or municipal bond funds. Please contact a Financial Consultant at Founders Investment Services by dialing 1-866-739-7064 for a more detailed discussion about these types of investments.
Securities and investment advisory services offered through Cetera Advisor Networks, LLC, Member FINRA/SIPC - Founders Federal Credit Union, Founders Financial Group, LLC and Founders Insurance Services are not affiliated with Cetera. Investment Services is a department of Founders Federal Credit Union. Registered Sales Branches are located at 607 N. Main Street, Lancaster, SC 29720; 1290 Old Springdale Road, Rock Hill, SC 29730; 100 Springcrest Drive, Fort Mill, SC 29715; 1307 Boiling Springs Road, Spartanburg, SC 29303.
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This article was written by Keith Benton, CFP® with Founders Investment Services. It was published in Founders FCU Transaction Newletter (April 2013).