Tax Free Muni Bonds

Ever wonder what tax free municipal or muni bonds really are? They can be a very lucrative investment option due to the fact that they have backing from a state, city or local government. A tax free municipal bond works similar to an IOU. It is a method these governments use to create funds for public projects.

There is one large advantage to this type of bond. The investor is usually exempt from all federal taxes on interest earned. The investor could also be exempt from state taxes if they reside in the same state that the project is being created.

There are two types of municipal bonds. The first is the general obligation bond meaning that they are backed by the issuer's ability to charge taxes. They are created to create fund for projects such as new schools, hospitals or other social services. The second type of bond is known as the revenue muni. They are issued by state or government sanctioned companies. For example gas, water and electric companies quite often fall into this category. Rather than relying on the entities ability tax, the revenue bonds rely on the customers paying their utility bills each month.

Unlike stocks and other types of bonds, there is very little information available to the investor as to how individual municipal bonds might perform. One thing the investor should look for is the individual credit rating of each of these companies. A good credit score is a fairly good indicator. To do some further checking, the investor could look at the general economy of the area. Check the income demographics and recent trends. Is it a large population or is it shrinking due to unemployment and low living standards? Is the economy diverse or reliant on one single industry? Investors should try to find out who is servicing the interest payments on the bonds as well. Do they have a good history of paying investors and paying them on time?

Although tax free municipal bonds may seem like a safe bet due to their government backing, they still need looking into. An economically depressed area could mean a very slow return or no return at all.