Tax Free Bonds Vs Taxable Bonds – What To Choose

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Written By Adrian Cruce

 

 

 

 

 

Bonds are quite similar to the regular IOUs that we used when we were younger. They are debt securities that you use as you lend the government money. In return, you are offered some sort of interest. We have access to so many different types of bonds that investors from all around the world currently use. However, the importance of comparing between those that are tax free and those that are taxable is really important.

tax free bonds

Understanding Taxes

Obviously, the benefit that can be found in the tax free bonds is that you do not pay state and local taxes. The investor will only really need to pay the federal taxes. We are faced with loans that have low interest rates. They are used in order to fund various public services or some public projects like housing, highways, schools, streets and sewage systems. The taxable bonds will require the investor to adapt and pay local and state taxes.

ROI

The one thing that is really important for the investor is the return on the investment that is made. The tax free bonds, sometimes referred to as municipal bonds, will have a low ROI when compared to a taxable opportunity because of the lack of taxes. Based on your current financial stability, you will want to constantly consider the returns since sometimes there are options that are better with the taxable bonds.

Keep in mind that the taxable income you have can lead towards a smaller ROI or can make you earn more. You need to take your current taxable structure into account since some people do pay more taxes based on various factors.

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Comparing Yields

When looking at yield percentages, the taxable bonds are always going to be higher. That is because of municipal bond tax exemption. We are faced with results that will depend based on where you live but the net taxable income and the filing status will need to be considered.

What you have to know is that the tax brackets for income do change from one year to the next. We do not actually have a percentage that we can use for calculating. High percentage yields should never actually make you choose one over the other. You need to be patient and always calculate everything from one deal to the next.