Assessing Cefs And Uits
Closed-end funds CEFs and unit investment trusts UITs are less well known packaged investment products that provide monthly income from a portfolio of bonds. CEF shares trade on the stock exchanges and use leverage to provide some of the highest bond investment yields for both taxable and tax-free bond types.
UITs have the unique feature among fund types of having a final maturity date when you know your invested principal will be returned. UITs are also available for both taxable and tax-free bonds including state specific municipal bonds.
References
Municipal Bond Funds With 10% Yields: Powershares National Amt
My third muni choice is an ETFthe PowerShares National AMT-Free Municipal Bond Portfolio , which is attractive for a bunch of reasons. For one, it has an incredibly low management feeits expense ratio is just 0.28%, and thats taken out of the fund so you never have to worry about it.
Mr. Market Remembers the Power of Munis
The fund is also geographically diversified, with issues from Texas, Florida, Alabama, Chicago, New York City,and Massachusetts comprising their top holdings. While the fund does hold 2% of its assets in taxable munis, this shouldnt cause anyones tax bill to jump dramatically, while the rest of the portfolio funds its 3.3% yield.
Put these three funds together, and we have a 4.7% average yield in extremely low risk tax-free income. At the same time, were insulating ourselves from the increasing insanity of the stock market, which has seen over 11% declines in a matter of days over the last year.
My Favorite Municipal Bond Fund
My favorite municipal bond fund is either a good buy or a great buy today, depending on your tax bracket. Its current 5.8% yield is federal tax-exempt. If youre in a 25% tax bracket, this equates to a 7.6% taxable yield. In the top 43.4% bracket? Youre banking a 10.2% equivalent payout.
More than 61% of its investments have a AA or AAA rating. And 88% of the paper it owns is investment grade .
Munis Are Tax Free Except When Theyre Not
As is true of almost anything thats related to taxes, munis can get complicated. A bonds tax-exempt status applies only to the interest paid on the bond any increases in the bonds value are taxable if and when the bond is sold. You also may owe taxes when you sell shares of a muni bond mutual fund.
Also, specific munis may be subject to federal income tax, depending on how the issuer will use the proceeds. If a bond finances a project that offers a substantial benefit to private interests, it is taxable at the federal level unless specifically exempted. For example, a new football stadium may serve a public purpose locally but provide little benefit to federal taxpayers. As a result, a muni bond that finances it is considered a so-called private-purpose bond. Other public projects whose bonds may be federally taxable include housing, student loans, industrial development, and airports.
Even though such bonds are subject to federal tax, they still can have some advantages. For example, they may be exempt from state or local taxes. And you may find that yields on such taxable municipal bonds are closer to those of corporate bonds than they are to tax-free bonds.
Also Check: How Much Tax Do You Have To Pay On Stocks
Q: I Need To Buy Some New Bond Investments I’m Torn Between Longer
If you are investing in an IRA or other tax-advantaged account like a 401, it never makes sense to buy tax-free bonds. Money withdrawn from tax-deferred retirement accounts is taxable as ordinary income, no matter how it was invested within the account.
Assuming that you’re investing in a taxable brokerage account, the answer is a little more complicated. Generally speaking, tax-free municipal bonds pay lower interest rates than taxable bonds of the same maturity length and credit quality. What you need to determine is whether the tax advantages make up for the lower rate.
Here’s a simplified example. Let’s say that AAA-rated tax-free bonds with 30-year maturities yield 2.5%, while a 30-year Treasury bond yields 3%. If you’re in the 12% federal tax bracket, this brings your effective yield from the Treasury bond down to 2.64%, so it would still be the better option. On the other hand, if you’re in the 22% federal tax bracket, it makes your effective Treasury yield just 2.34%, so the tax-free bond would be the better choice.
State taxes could make the benefit even better.
How Much Do Municipal Bonds Earn
Muni bonds often have lower yields than corporate bonds and other taxable bonds. Municipal bond rates are lower because they are considered relatively safe as compared to other assets. However, its important to note that the tax efficiency of municipal bonds also plays a role in their desirability.
For example, lets say youre in the 24% federal income tax bracket. You find a municipal bond with a tax-exempt yield of 5%. To get the same after-tax income benefit from a taxable bond, youd need a yield of 6.6%. The difference is even more pronounced at a higher tax bracket. In the 35% tax bracket, youd need a yield of 7.7% to see the same benefit in a taxable bond.
Read Also: When You File Taxes Is It For The Previous Year
Heres How To Invest In Iowa Municipal Bonds
Iowa municipal bonds can save Iowans a lot of money in taxes because of Iowas high state income tax rate. But, many investors are not investing in the right municipal bond or fund to maximize their potential tax savings.
We covered the topic briefly in one of our latest YouTube series:
This post will go into detail about how to determine if Iowa municipal bonds are right for you, and the best way to invest in Iowa municipal bonds today.
And as a warning, be cautious investing in Iowa municipal bonds that are being pushed from brokers. As a fee-only and fiduciary investment adviser, we dont receive commissions for selling these bonds to our clients. You can be sure our advice is objective and fair.
If you are considering investing in Iowa municipal bonds, please schedule a free introductory meeting to make sure they are right for you.
What Are Revenue Bonds
Revenue bonds are often used to finance ongoing projects, such as infrastructure upgrades. Unlike general obligation bonds, revenue bonds arent tied directly to a general taxing authority. Instead, the taxes or fees charged are designed specifically to ensure the muni bond debt will be repaid. You can break revenue bonds into two main types:
- Tax revenue municipal bonds. These revenue bonds receive backing from a portion of ongoing taxes. For example, some of the income from a utility tax, resort/hotel tax, excise tax or sales tax might be earmarked to pay off the debt.
- Enterprise municipal bonds. Rather than relying on taxes, enterprise revenue bonds focus more on the income raised by the costs of using something. Often, these types of bonds are issued by entities that charge for a service, such as utilities, airports, hospitals and even sewer authorities. The income generated by payers is used to secure the debt.
For example, a city looking to create a convention district might issue municipal bonds and then earmark a portion of the money raised through a hotel occupancy tax to secure a tax revenue bond. On the other hand, a city might secure an enterprise revenue bond to improve and maintain a stretch of interstate with a toll charge.
Either way, expected ongoing revenue streams are used to back the bonds, rather than the general tax base.
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Municipal Bond Funds Allow You To Enjoy The Benefits Of Tax
While stocks can supercharge a portfolio, getting income out of an all-stock portfolio is difficult. Withdrawing at the wrong time can cause an investor to sell at a significant loss, hurting long-term returns. Then there is the tax issue: With long-term capital gains taxes of up to 20%, many retirees will find themselves being squeezed by the IRS as they try to live off their life savings.
There is a solution to these problems: municipal bonds, and municipal bond funds.
“Munis” have been favorites of American retirees for generations. That’s not only because they provide tax-free income, but because their low volatility and high yields mean selling at a loss is very hard to do.
“Muni bonds are a good way to provide consistent income, and the tax angle can also provide additional value,” says Ben Barzideh, Wealth Advisor with Piershale Financial Group. “Also, bonds tend to fluctuate much less than stocks, so it brings a level of diversification and safety for the overall portfolio.”
unless they buy municipal bonds through the big guys. You can do this via municipal bond funds, which are issued by the major bond buyers, who in turn use your cash to go and buy more muni bonds.
Read on as we look at three of the best municipal bond funds on the market right now.
- Assets under management: $121.0 million
- Distribution rate: 3.3%
- Expenses: 1.76%
- Assets under management: $252.4 million
- Distribution rate: 4.8%
- Expenses: 2.61%
Investing In Municipal Bonds Not So Easy In Iowa
Municipal bonds offer a lot of benefits, but if you want to buy where do you go?
You would think it would make sense to just search Vanguard, or any other large mutual fund company for a municipal bond fund, right?
Heres one of Vanguards largest municipal bond mutual funds:
But it is not that easy.
Iowans looking to invest in Iowa municipal bonds will be very disappointed, because large municipal bond funds such as this one hold very few municipal bonds from Iowa:
Remember, Iowans only get a break from state income tax for municipal bonds from Iowa. And if you read the fine print of this fund , a very small portion of the funds income comes from Iowa municipal bonds. For this particular Vanguard Municipal bond fund, only 0.37% of your income from this fund would be eligible for a state tax break.
What does that mean for a hypothetical $100,000 investment in this Vanguard fund compared to if you had invested solely in Iowa municipal bonds?
The Vanguard fund currently yields 2.7%. That means your $100,000 investment will provide $2,700 in income per year. Although you do not have to pay federal taxes on this income, you will need to pay 8.98% Iowa state income tax, or $242. In total, you would collect $2,458 after taxes.
Investing in Iowa municipal bonds would save you that $242. Plus, Iowa municipal bonds today typically have higher yields than the municipal bonds from other states that make up these big municipal bond funds.
Recommended Reading: Do You Need To Claim Unemployment On Taxes
Gauging The Safety Of Your Tax
For those of you who want to gauge the safety of your tax-free municipal bonds, the father of value investing, Benjamin Graham, had some suggestions in his book “Security Analysis.” For example, you are almost always going to want to have minimum population requirements, a history of punctual bond payments, and a diverse underlying economy to support the cash flows.
Above all, you want to know
Backed By Taxes Or Backed By Revenue
To pay back the interest and principal on a bond, the borrowing municipality can raise the funds one of two ways: either using taxes or using revenue. This informs what type of muni bond the issue will be.
- Tax-backed When a municipality uses taxes to pay back the debt, the bond is called a “general obligation bond.” This just means it’s backed by the taxing power of the issuing city, county or state. For example, a bond that is being issued to build a new high school would probably be a general obligation bond because the town where that school is located is “obligated” to back the loan. The residents’ property taxes will make up the funds that are used to pay the interest and principal. You may be familiar with bond issues on your local election ballots. Many municipalities let voters decide yes or no on bond issues because ultimately, the bond issue will raise the citizens’ taxes.
- Revenue-backed The other type of bond is called a “revenue bond.” A bond that is issued to improve a local water system would be one example of this kind of bond. The citizens’ water bills would be used to operate and maintain the water system and that revenue would then go toward the bond’s interest and principal payments.
Also Check: How Do You Do Taxes
Other Benefits Of Iowa Municipal Bonds
One of several unique benefits available for those who delve into the details of Iowas municipal bonds is identifying a few types of the bonds listed above that provide not only tax free income, but also tax free capital gains which is very rare for municipal bonds and certainly does not come with municipal bond funds.
What does this mean? Certain municipal bonds may be better than others for certain scenarios. Knowing what types of Iowa municipal bonds are best can save you additional money from taxes.
For example, in a period rising interest rates, Iowa municipal bonds may be trading below their par value . IF you can find certain municipal bonds that not only provide tax free income but also tax free gains those bonds currently priced below par may provide higher after-tax returns than other municipal bonds.
Municipal Bonds: Wall Street’s Hidden 65% Income Secret
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Wall Street says you have to settle for the pathetic 2% yields most folks scrape by on from 10-year Treasuries, or your typical S& P 500 stock.
Dont believe them.
Because theres a far better way to bankroll your retirement that they wont tell you about: municipal bonds.
While their name sounds boring, thats the last word Id use to describe the income they throw off: munis pay dividend yields of 5% and often much more, thanks to a unique tax advantage.
In fact, the 3 off-the-radar plays Ill show you below can let you pull a steady 6.5% out of some of the safest muni bonds out there.
Municipal Bonds: A Rare Gift From the Taxman
Municipal bonds income gets a big boost from a surprising source: the IRS. Thats because the income they hand you is almost always federal-tax free and, in most cases, free of state taxes, too.
The effect? Dramatic.
Lets imagine a muni bond yielding 5%. If youre in the 28% federal tax bracket, youd need a 6.94% yield on corporate bonds or dividend stocks to get the same after-tax income our muni bond pays.
Theres a second, knock-on bonus here: you can buy and hold municipal bonds without worrying about the extra income bumping you up into a new tax bracket.
These are just a couple perks of investing in municipal bonds. Now lets look at the best way to tap them for outsized payouts with far more stability than you get from your typical dividend stock.
How Municipal Bonds Work
Risks of Municipal Bonds
We can do better.
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Example Of Calculating After
Say you are looking at a tax-free municipal bond for Riverside California rated AA by Standard & Poor and Aa2 by Moody’s. It matures on Aug. 1, 2032, but it is , so the yield to maturity of 2.986% is higher than the yield to worst, which is 2.688%. In this case, for the sake of conservatism, we’ll assume the yield to worst actually comes to fruition and go with the 2.688% rate. How much would a corporate bond need to yield to provide you that same after-tax income? We’d take the taxable equivalent yield formula and plug in what we know:
- Step 1: 2.688 ÷
- Step 2: 2.688 ÷ 0.5807
- Answer: 4.63%
That is, to end up with the exact same amount of after-tax income, you’d need corporate bonds of comparable quality maturing in August of 2032 to pay you 4.63% just to break even with the tax-free municipal bond you’re considering.
Now consider that the only comparable bonds are rated AA+ by S& P and A1 by Moody’s for General Electric Capital maturing on Dec. 15, 2032, with a yield to maturity of 3.432%. They are non-callable so there is no yield to worse.
That rate isn’t good enough. You wouldn’t want to buy taxable corporate bonds under these conditions your opportunity cost makes them too unappealing.
Using Asset Placement To Your Advantage
One way you can arbitrage the tax code is to use a strategy called asset placement, which is putting the right asset in the right vehicle to maximize benefits and minimize your tax burden.
For example, you wouldn’t choose to own tax-free municipal bonds inside of a tax shelter such as a Roth IRA, because those assets are already tax-protected. You’d be better off buying the higher-yielding corporate bonds for use in your IRA, as those bonds are exempt from federal and state taxes while within the protective confines of that special account.
Non-profit organizations, charitable institutions, and certain pools of capital, such as endowment funds for higher education, are likely going to have little use for tax-free municipal bonds, as they’re almost always going to be able to find a better deal elsewhere.
On the other hand, your taxable brokerage account would be a good place to put tax-free municipal bonds in order to take advantage of the tax exemptions.
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Do Bonds Produce A Monthly Income
Most bonds make semi-annual interest payments.
The standard interest payment interval for investment bonds is twice a year or semi-annually. For investors who would like to receive monthly interest checks, there is one type of bond that is an exception to the rule and a couple of other paths to turn bond interest into monthly income. Select the bond investment vehicle that fits with your portfolio size and investment experience.
