Tax Free Bonds

What is a bond?

Before diving into tax free bonds, I recommend going to definition of bonds.

Which types of bonds are tax free?

All bonds from TreasuryDirect.gov are tax free for state and local taxes, but not federal taxes. Only a small set of bonds are truly tax free. The truly tax free are called municipal bonds. They are issued by states or cities as loans to fund public projects - like roads, bridges, schools, etc.

How can I invest in bonds that are tax free?

You can buy the bonds through most stock brokers, but I don't recommend it. I recommend a municpal bond fund with a low expense ratio. I can recommend Vanguard. They are simple and easy to use and they have rock bottom expense ratios. The biggest problem is that their mutual funds require a minimum of $3,000.

Should I invest in tax free over taxable?

That depends on your tax bracket, whether the bonds will be in a retirement account or not, and what the current interest rates are for each. First of all, if you're putting the bonds in a tax sheltered account - like a Roth IRA - there's no reason to go with the tax free versions. If you're not going with a tax sheltered account and you're in a higher tax bracket, the tax free option is more likely to make sense for you because the interest you earn on your bonds is taxed at your normal tax rate. Therefore, your taxable bond yield will be effectively lower.

For example, lets say you are in the 25% tax bracket. You can buy the intermediate-term tax free bond fund from Vanguard that earns you 3.44% or the total bond market index (taxable) bond fund that earns you 4.04% (yields are quoted at time of writing). The expense ratios are almost identical. In this case, you should get the tax free bond would be the wiser choice because after taxes you'll earn 3.03% on the taxable bond (4.04% multiplied by 0.75 equals 3.03%).

return from tax free bonds to safe investing

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