At its core, a triple tax-free municipal bond is just like any corporate bond — it is a debt instrument, a loan given to a government authority or municipality in order to help it meet certain financial objectives or complete projects in the community.
As with any bond, the principal (also called par) is paid back at maturity and interest payments are made between the time the bond is purchased and the time that it matures.
Why Are Municipal Bonds Called Triple Tax-Free?
Municipal bonds are called triple tax-free because the interest payments are not subject to federal taxes. When an investor purchases a municipal bond from a local authority in a state or city that he or she resides in, that interest is not subject to state or city taxes, thus making it triple tax-free.
Municipal bonds are low risk because they are backed by the issuer and its authority to collect taxes and utility fees. This low risk means that municipal bonds have a lower interest rate than certain corporate bonds.
Trading at a Discount or Premium
Municipal bonds are issued at par, but can sometimes be traded for less than par. This is called "trading at a discount." When an investor buys a municipal bond at a discount, not only do they earn money through the coupon or interest payments, but when the full principal is paid off, that creates an additional gain.
Meanwhile, bonds that are purchased for more than par are purchased "at a premium." Bonds with a higher interest rate than the going rate might be sold at a premium.