Municipal bonds are one of my favorite types of bonds.
Not only do you get tax-free returns*, but you also get to watch your community grow and improve.
Keep reading as I explain why in the post below.
What Is A Municipal Bond?
A municipal bond is considered a debt security and is used to finance a capital expenditure of a state, county, or municipality.
Let me give you an example:
Sometimes you just need your money now. When you or I as individuals need money now, we may use a credit card or take out a longer-term loan like a mortgage. When a city or county needs money now they issue municipal bonds.
Municipal bonds, sometimes called “munis”, make for great investments because the money you loan to the municipality goes towards services you might use like schools, parks, roads, or utility infrastructure.
Not only that, but the money they pay you in interest is often tax-free. That’s right, it’s not just for millionaires, you too can make money and pay $0 of it in income taxes by investing in municipal bonds!
2 Types Of Municipal Bonds
While there are many defining characteristics of Municipal bonds, I will divide them into two main types, general obligation bonds and revenue bonds. These names refer to how the bonds will be repaid.
General obligation bonds (GO) are paid as a general obligation of the government entity’s budget and secured by the full faith and credit of their taxing power. When citizens vote “YES” on a proposed bond measure, it becomes the “General Obligation” of the community and the loan is usually paid through property taxes.
Revenue bonds are paid out of a specific revenue stream. A good example of this would be the tolls from a new bridge going towards the bonds used to fund that bridge’s construction, or bonds for a new stretch of road being secured by fuel taxes. A local example of a revenue bond is Sutter Street in Folsom. A revenue bond was issued to improve the historic street and was paid with sales tax revenues.
GO bonds are usually considered higher-quality bonds due to the promise that taxes could be raised to pay you your interest due – but that is not universally true.
Both of these types of bonds have many variations, making it important for you to read the bond’s official statement and any continuing disclosures to ensure you understand everything about a bond before you choose to invest in it.
Advantages Of Municipal Bonds
One of the primary advantages of a municipal bond is the tax benefits. Local governments want you to loan them money so they usually incentivize you by excluding income from their bonds from your taxable income. Not to mention, most states offer tax breaks on various partnered states’ bonds as well.
On the federal level, municipal bond income has been exempt from the federal income tax since its inception in 1913 after the passage of the 16th amendment.
Municipal bonds often have a higher credit rating than fiscally comparable corporate bonds. In other words, municipal bonds generally have a lower rate of defaulting on payments than corporate bonds. This is attributed to the ability of cities and counties to call on state and federal funding to alleviate economic downturns.
Another great attribute of a municipal bond is that you can help your community improve!
Examples Of Municipal Facilities In El Dorado County
Beyond the tax-free earnings potential, I like municipal bonds because I can see when they make a difference in my community.
As a personal example of muni bonds at work, in 2009 voter-approved measure Q to replace all the football fields at the high schools in the county. To fund this project, the measure called for $66.3 million in bonds to be offered and an extra property tax of $0.16 per $1,000 of property value to pay for it.
I got to exercise and play on that field in school and some investors out there are still being paid 4.68% tax-free through the county for loaning the money to build it.
A more recent example of municipal facilities that were funded by these bonds is the solar panels that were built in 2021 at El Dorado high school.
What Does It All Come Down To?
Municipal Bonds are an investment vehicle that all investors should consider in their portfolios. Plus being able to watch your community grow because of your investments is always a nice bonus.
And if you have any questions about anything finance-related, reach out!
*There are some exceptions, check with your tax advisor.
