Municipal bonds may be an option for income-oriented investors looking to reduce federal and, possibly, state income tax bills.
The reason: Investment-grade municipal bonds often combine two characteristics generally not shared by other investments: tax-exempt income and high credit quality.
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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?
- 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.
New-issue municipal bonds
While there are no transaction fees on new-issue bonds, Schwab receives a selling concession for distributing the security to Schwab clients.
Secondary market municipal bonds
- Online price
- Transaction Fee of $1 per bond ($10 minimum, $250 maximum per trade*)
- Broker-assisted trade
- Online price + $25 per trade
*Schwab reserves the right to act as principal on any fixed income transaction, public offering or securities transaction. When Schwab acts as principal, the bond price includes our transaction fee and may also include a markup that reflects the bid-ask spread and is not subject to a minimum or maximum. 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. When Schwab acts as agent, a commission will be charged on the transaction.
Types of municipal bonds.
There are two major categories of municipal bonds:
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.
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.
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®.
Research and order new-issue municipal bonds online using the New Issue Calendar in Schwab BondSource.
- Review upcoming offerings in which Schwab may participate.
- Place orders for new-issue municipal securities.
- Access and review preliminary official statements.
- Review preliminary price and yield information once available.
- Search upcoming offerings by a variety of criteria.
- See past offerings in which Schwab has participated, and access the official statements for those offerings.
BondSource lets you search for the most current municipal bond offerings. BondSource also gives you access to the secondary market.
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.
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