Tax-Free Municipal Bonds: Pros And Cons

Tax-free municipal bonds are popular investment vehicles for folks who are trying to get consistent returns. A tax-free bonds adviser, though, will tell you that these financial instruments have their pros and cons, so let's take a look at what you should know.

Pro: They're Tax-Free!

Tax-free bonds are often directed into IRAs, annuities, and other pension and retirement accounts because they maximize tax benefits. Combined with other tax-advantaged structures, these bonds can bring your tax bill close to zero as long as you navigate the system carefully.

Con: Understanding the Varieties Out There

Tax-free municipal bonds are funded from one of three common sources. There are bonds backed by utility payments from a city's customers, others backed by property tax assessment money, and bonds backed by the full faith and credit of a city. The first two have their flaws because a city's access to cash may vary, especially over decades, when it depends on X number of people paying Y amount of bills. On the other hand, the full-faith-and-credit varieties offer the lowest interest rates because they are considered the most secure. You may need to talk with a tax-free municipal bonds adviser to determine how risks and rewards balance out with bonds.

Pro: Wide Range of Terms

When looking at other interest-based options, you're usually dealing with things like treasury bills that can take years or even decades to mature. Municipal bonds come in terms ranging from months to decades. You can easily shop the market to find something that meets your needs. If you're planning for a vacation in a year, for example, that money can go into a short-term bond that'll be paid out in time.

Con: Default Risks

Although municipal bonds as a class are considered safe investments, cities can and do declare bankruptcy. The highest rates of returns are for bonds from cities with the greatest bankruptcy risks. It's never a good idea to invest in bonds if you're not comfortable taking a hit on such losses. Conversely, high-yield bonds may still pay back their principals before their issuers go under anyhow.

Pro: Lower Volatility

Folks who've seen enough of the stock market swinging up and down often turn to bonds. If you want the chance to trade, there is a secondary market. On the flip side, you can always just stay in your lane and see your bonds to maturity.

Talk to a financial adviser for more specific advice.