The quoted yields for munis tend to be lower than those of corporate or government bonds because of the tax advantages. Remember, interest on corporate bonds is fully taxable and government bonds are taxable at the federal level even though they are tax-exempt at the state and local levels.

Munis, however, are tax-exempt at the federal level and can be exempt at the state and local levels. If your client is in a high tax bracket, the taxable equivalent yield on municipal securities can be much higher than on fully taxable securities. There are a couple of exceptions to this rule:

Alternative Minimum Tax (AMT)
AMT was designed in the late 1960s to confront the perception that the rich do not pay taxes. If the IRS determines your client must pay the AMT, the tax advantage he expected when he invested in munis evaporates, along with many other tax shields he was relying on.

However, there is some good news here: the only munis that are subject to the AMT are those that fund "private activity". Which ones are they? Who knows! The vast majority of munis are not subject to the AMT, but it is still a good idea to look at the cover of the issue's indenture, or official statement, before selling its supposedly tax-exempt bonds to your client.

Triple Tax
If your client is buying debt from the state he or she happens to live in, or of any municipal entity within that state, then your client is entitled to tax exemption at the state and local levels. This is sometimes called triple-tax-exempt or triple-tax-free.

On the other hand, if your client lives elsewhere it is your responsibility as the registered representative to explain that interest income from the bond may be taxed at the state and local levels even though it is shielded from federal income taxes.

Remember, federal income tax is much greater than state and local income taxes - in fact, many localities and several states have no income tax at all. Therefore, munis, which are federally exempt, make for a much stronger tax shield than government bonds.

Munis are thus the preferred fixed-income investment of the well compensated.

The article Weighing the Tax Benefits of Municipal Securities contains further information on determining whether the tax exemption offered by munis is beneficial.

Let's take a closer look into determining the suitability of a particular municipal bond in your client's portfolio.



Determining Muni Suitability For Clients

Related Articles
  1. Personal Finance

    Weighing The Tax Benefits Of Municipal Securities

    Find out how to determine whether the tax exemption offered by "munis" benefits you.
  2. ETFs & Mutual Funds

    An Unprecedented Opportunity In Municipal Bonds

    As interest rate/taper and default fears have taken hold, investors have fled muni bonds in spades. That outflow could be just what value hunters are looking for.
  3. Financial Advisor

    Top 4 Ways to Avoid Muni Bond Mistakes

    Muni bonds are often perceived as safe investments. But it's important to do some thorough research before investing.
  4. ETFs & Mutual Funds

    Tax-Free Income Funds You Should Shortlist (FKTFX, VLTCX)

    Looking for holdings for the fixed-income portion of your investment portfolio? These top tax-free income funds may fit the bill.
  5. ETFs & Mutual Funds

    The 6 Most Liquid Muni Bond ETFs (MUB,SHM,TFI,ITM)

    Looking for safety in an uncertain world? Consider these liquid muni bond ETFs.
  6. Markets

    Feeling Taxed? What You Need to Know about Munis

    Find out why investors have any number of reasons to feel stressed, now that tax time is coming.
  7. Financial Advisor

    Vanguard Readies Muni Bond ETF

    Vanguard is set to roll out a muni bond ETF, the firm's first.
  8. Managing Wealth

    Muni Bonds, Taxable Bonds or CDs: Which is Best?

    Here's how to tell if municipal bonds are a better investment than taxable bonds or CDs.
  9. Markets

    What Is A Municipal Bond?

    A municipal bond is a debt instrument used by a city, state, county or other local government authority to raise money for a project. Municipal bonds, often called munis, are considered a debt ...
  10. ETFs & Mutual Funds

    MUB: iShares National AMT-Free Muni Bond ETF

    Take an in-depth look at the iShares National AMT-Free Municipal Bond ETF, a highly diverse and very popular muni bond fund.
Trading Center