How to Choose a Tax Free Municipal Bond or Muni?

Municipal bonds or the munis are bonds issued by the local government or the state government. Profit earned from the munis are generally federal tax free and could be relief from local government tax as well, if they were bought in your own state of residence.

Basically risks for buying the munis are low. However, you can improve on the overall security by properly selecting the munis.

How to Choose a Tax Free Muni?

Security Concern #1. If what concerns you is the risks of munis, then you should choose those rated by the rating agencies. Take note that not all the munis are rated. Munis that are rated are obviously safer than those unrated. Different grading systems are used by different rating agencies, but they are basically ranging from A to D, with A being the safest and D being the riskiest.

Security Concern #2. Your second security concern could be: "If the bond issuer default on the payment, how would I get compensated?" Then, you should consider purchasing munis guaranteed by the insurers. Just in case the bond issuer default on the payment, the insurer would compensate the amount. However, you need to sacrifice a bit on the rate of return.

Tax Concern. If your main concern is the tax, then you should go for bonds that offer triple tax free. Instead of purchasing national munis, you should purchase state munis as national munis are entitled to only federal tax free. Search for munis from your own state that entitle you to federal, state and local tax free.

Liquidity Concern. The longer term the bond, the less liquid it becomes. Choose a shorter term muni to avoid liquidity issue. Shorter term munis are also more predictable.

Bond Yield Concern. If a muni is callable, then you would get lesser yield when it is called. Therefore, purchase munis which are non-callable to get better yield and avoid uncertainties.

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