Front Range Financial Consulting

New hospitals. Improved roads. More schools. Every day, we use services maintained by our government. But have you ever wondered how these projects are funded? Certainly, taxes foot a portion of the bill. But sometimes, local and state governments need additional money. Instead of getting a loan through a bank, government officials look to the very people the projects will help - the general public. That’s right. Average citizens fund large-scale projects by loaning money to the government. But how? Most of us don’t have the amount of money needed to build a new school or improve a highway system. Instead, we provide these loans by purchasing municipal bonds.

At a glance

• Municipal bonds are federal-tax-free investments.
• Investors in higher tax brackets tend to benefit more from tax-free earnings.
• Municipal bonds help government agencies fund public projects such as improving hospitals, roads and schools.

Income from municipal bonds are not subject to federal income taxation; however, they may be subject to state and local taxes and, for certain investors, may be subject to the federal alternative minimum tax.

What is a municipal bond?

Municipal bonds are basically loans to local and state governments. Think of the investor as a bank. He or she lends money by purchasing a municipal bond. This loan helps supplement operating budgets and pay for public projects - like new highways and schools. The municipality pays interest on the loan, which is then distributed to the investor as federal - and sometimes state and local - tax-free income. When the loan term is up, the principal balance is returned to the investor.

Income from municipal bonds are not subject to federal income taxation; however, they may be subject to state and local taxes and, for certain investors, may be subject to the federal alternative minimum tax.

Choosing a bond that’s right for you

With thousands of bonds available today, how can you choose appropriate ones? Raymond James is one of the few firms that conducts research in this area. Our municipal fixed income research analysts cover a broad range of municipal bonds, including:

• Healthcare
• Housing
• Public power
• School districts
• Student loans
• Transportation
• Escrow

You can have direct access to our extensive research reports through your financial adviser.

Income from municipal bonds are not subject to federal income taxation; however, they may be subject to state and local taxes and, for certain investors, may be subject to the federal alternative minimum tax.

Why invest in municipal bonds?

Earnings on municipal bond investments are free from federal taxes. And if you invest in a bond from the same state in which you live, it may be free from local and state taxes, as well. While this may sound enticing to all investors, it may not be a wise choice for some. Because they have a tax-advantage, these bonds generally pay lower interest rates than most corporate bonds. Therefore investors who are in higher tax brackets usually benefit the most from municipal bonds. Read our example below to find out why.

Example

Tom is in the 28% federal tax bracket. He invests in a municipal bond that pays 6% interest. If he had invested in a fully taxable investment, he would need to earn 8.3% interest to receive the same benefit as the municipal bond.

Angela is in the 36% tax bracket. She invests in the same municipal bond at 6% interest. She would need to find an investment with 9.4% interest to break even with the rate of return from her municipal bond.

Compared to Tom, Angela would need to find a much higher rate of return if she chose a different investment alternative. Instead, she may choose to invest in the municipal bond, while Tom finds another investment alternative.

This is a hypothetical example and is not intended to reflect the actual performance of any particular security.

Income from municipal bonds are not subject to federal income taxation; however, they may be subject to state and local taxes and, for certain investors, may be subject to the federal alternative minimum tax.

How do I invest in municipal bonds?

Municipal bonds are bought and sold in the over-the-counter market. Before investing, however, determine whether the issuer can meet the financial obligations that are incurred with a bond. You can evaluate the issuer by reading through disclosures provided by your Raymond James financial adviser, free of charge, and also examine credit ratings through ratings agencies such as Moody’s Investors Service, Standard & Poor’s and Fitch. You should also evaluate the bond in terms of your financial objectives. When is the maturity date? How much interest will be earned? What is the market doing right now?

The best way to answer these questions is to speak with your financial adviser who is knowledgeable about the bond market.

Municipal bond interest is not subject to federal income tax but may be subject to AMT, state or local taxes. Income from taxable municipal bonds is subject to federal income taxation; and it may be subject to state and local taxes. Municipal securities typically provide a lower yield than comparably rated taxable investments in consideration of their tax-advantaged status. Investments in municipal securities may not be appropriate for all investors, particularly those who do not stand to benefit from the tax status of the investment. Please consult an income tax professional to assess the impact of holding such securities on your tax liability.