What is a municipal bond?
States, cities, counties, and other local governments, as well as enterprises that serve a public purpose, such as universities, hospitals, and utilities, issue municipal bonds. They usually pay interest that is exempt from federal income taxes. Interest may also be exempt from state income taxes if an issuer in your home state issues the bond.
What does Schwab offer?
- More than 40,000 municipal bonds offered1
- Ability to purchase new issues online
- Seamless integration with major bond platforms
- Access to assistance from Fixed Income Specialists
Why would Schwab recommend municipal bonds?
Municipal bonds can make an attractive investment option for conservative, income-oriented investors because the interest income is often exempt from federal, and potentially state, income taxes. Historically, municipalities exhibit repayment patterns that are stronger than those exhibited by corporate borrowers in the same credit rating bracket, meaning they tend to pay interest and principal on time, as scheduled.
What does Schwab charge to trade municipal bonds?
New-issue municipal bonds
While there are no markups on new-issue bonds, Schwab receives a selling concession for distributing the security to Schwab clients.
Secondary market municipal bonds
- Online price
- Markup of $1 per bond ($10 minimum, $250 maximum per trade)
- Broker-assisted trade
- Online price + $25 per trade*
*Schwab uses the same pricing schedule for sell orders, which must be placed through a broker and are subject to a $25 broker-assisted fee.
Talk to a Fixed Income Specialist to learn more about municipal bond pricing.
Types of municipal bonds.
The municipal bond market is a $3.7 trillion market with approximately 50,000 eligible issuers. There are two major categories of municipal bonds:
General obligation (GO) bonds are backed by a specific tax source or by the full taxing power of a state or local government.
Revenue bonds are backed by a specific revenue source from a public enterprise, such as water and sewer service or a hospital.
Take a closer look at the benefits.
Interest income from most municipal bonds is often exempt from federal income tax—and if the bond is issued in the state where you live, interest may also be exempt from state income taxes. If you're in a high tax bracket, then tax-free bonds may provide a higher after-tax yield than those provided by similar taxable investments.
Federal Marginal Income Tax Rate
Most municipal bonds pay interest twice a year, so barring default you know exactly how much to expect and when you'll receive it. Plus, with a stated maturity date, you know when you will get your principal back from the issuer.
Historically low chance of default
Municipal bond payments are typically backed by taxes or user fees from services that are often essential. This helps reduce their potential for missing interest and principal payments.
Source: "Moody's U.S. Municipal Bond Defaults and Recoveries, 1970–2014," July 2015. Moody's cumulative default rates calculated from marginal default rates, which represent the probability that an issuer that has survived through a particular date will default over the next time interval (one year in this case). Default rates only include bonds rated by Moody's. Past performance is no indication of future results.
Opportunity to invest your money locally
If you buy municipal bonds issued in your home state, you may be more knowledgeable about the issuing municipality or more familiar with the projects being funded. As a result, you may be able to make better decisions about which municipal bonds you're comfortable buying.
Review the risks.
Municipal bonds are subject to the following types of risk: call, interest rate, reinvestment, purchasing power, material events, catastrophic call, and AMT, as well as other risks commonly associated with fixed income securities.
Municipal issuers provide regular ongoing disclosure about certain events that might affect the value of the securities they have issued. These events could make the securities riskier and result in loss of cash flow to bondholders. Investors should read material event disclosures before buying.
Extraordinary redemption (aka catastrophic call)
An extraordinary redemption is a provision that gives issuers the right to call bonds due to unforeseen or unusual circumstances. This call feature is in addition to any other calls the bond contains. When a bond is called through extraordinary redemption, you generally receive par value. This poses the greatest risk when you buy bonds at a premium.
Alternative Minimum Tax (AMT)
Some types of municipal bonds are subject to the AMT, which is an alternative way of computing taxes that is mandated by the IRS for income over certain levels. These bonds, also called Private Activity Bonds, may be taxable to an investor. If you are unsure of your AMT status, Schwab recommends that you contact your tax advisor before buying municipal bonds subject to AMT.
If a bond issuer repays the principal (calls) of the bond before its stated maturity date, the investor could miss out on future interest income payments.
If the credit rating of the municipal bond changes to a lower rating, the value of the bond may decrease. This can occur if the issuer defaults.
If interest rates rise, the market value of the municipal bond may decline, which could be a risk to the investor trying to sell before the maturity date.
If interest rates are low and a bond reaches its maturity date or the issuer calls the bond, the investor could be left with a lower yielding reinvestment option and possible reduction in cash flow.
Inflation (purchasing power)
If prices rise at a higher rate than investment returns, then money buys less in the future. The risk is greatest if the bond has a long time before its maturity.
Find municipal bonds with Schwab BondSource®.
Schwab tips: Some things to consider before you invest.
Go for quality
Consider high-rated, general-obligation, and essential-service revenue bonds. These municipal bonds generally have a very low chance of missing interest or principal payments.
Prices for municipal bonds can vary. Whether you are buying or selling, compare prices to find the deal that's right for your situation. This can help you maximize your return.
Take advantage of resources to help you make decisions.
Talk to a specialist
Get assistance from over 100 Schwab Fixed Income Specialists, who draw on an average of over 21 years of experience.2
Do the research
Access commentary that provides you with greater insight.
Attend a workshop
Learn more through educational workshops at your local Schwab branch.
We're here to help
Clients of independent investment advisors: You may also contact your advisor or call Schwab Alliance at 800-515-2157.
1. As of December 2015.
2. As of January 2016.
Fixed income securities are subject to increased loss of principal during periods of rising interest rates. Fixed income investments are subject to various other risks, including changes in credit quality, market valuations, liquidity, prepayments, early redemption, corporate events, tax ramifications, and other factors.
Interest income on individual municipal bonds may not be tax-exempt, depending on the bond issuer, the type of bond, or your state of residence. Interest income on bonds issued by U.S. states, cities, counties, their enterprises, and U.S territories is generally federal-tax-exempt, and state-tax-exempt for residents of the state in which the issuer resides. In addition, municipal bond interest for bonds issued in U.S. territories is generally state-tax-exempt in all 50 states. Consult your tax advisor regarding your personal situation.
Income may be subject to the alternative minimum tax (AMT), and capital appreciation from discounted bonds may be subject to state or local taxes. Capital gains are not exempt from federal income tax.
Schwab reserves the right to act as principal on any bond transaction. In secondary market principal transactions, the price will be subject to our standard markup for purchases and a markdown for sales, and may also include a profit to Schwab in the form of a bid-ask spread.
When trading as principal, Schwab may also be holding the security in its own account prior to selling it to you and, therefore, may make (or lose) money depending on whether the price of the security has risen or fallen while Schwab has held it. Schwab will not act as both principal and agent simultaneously in the same transaction.
This information is not intended to be a substitute for specific individualized tax, legal, or investment planning advice. Where specific advice is necessary or appropriate, Schwab recommends consultation with a qualified tax advisor, CPA, financial planner, or investment manager.
The Schwab Center for Financial Research is a division of Charles Schwab & Co., Inc.