What is a Tax Free Municipal Bond?

A tax-free municipal bond is a means of raising funds, usually for capital projects, by local governments and government entities below the statewide level. The tax-free municipal bond, in turn, serves as an investment vehicle for the investor seeking a relatively conservative cash growth opportunity. These bonds are often called "munis" for short, and are generally very safe investments.

Issuance

Government bodies usually issue tax-free municipal bonds to fund large capital expenses and improvements, like parks, downtown restorations, schools or airports.

Tax Free Definition

Income from tax-free municipal bonds is always 100 percent exempt from federal income taxes. The income from these bonds is also usually exempt from all state taxes, provided the bond holder lives in the state issuing the bond.

Time Frame for Pay Out

The payout on tax-free municipal bonds varies by bond and issuer, lasting anywhere from a few months to 30 years or even more.

Safe Investment

Like most investments, there is some element of risk in a municipal bond, as the government bond issuer may default on the bond if the project goes awry or the government agency is unable to pay. However, municipal bonds enjoy much safer ratings than corporate bonds.

Repayment to Bond Holder

The repayment schedule varies by bond and government agency. Generally speaking, smaller municipal bonds are paid back in full at maturity, while larger bonds are paid back on a regular basis through an amortization schedule.

References

• The Bond Buyer: Tax-free Municipal Bonds