How Do Tax Free Bonds Work

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How do tax free bonds work. You have a choice between investing in general corporate bonds or tax free municipal bonds. Zero coupon bonds are a specific type of bond that has specific tax implications. Twice since 1990 the interest rate for municipal bonds crept higher than for treasury bills source. You will pay taxes on any earnings from these debt securities.

In simple terms irrespective of the income slab one need not pay any income tax on the interest income. The interest that an issuer can offer to investors depends on the yield of government securities prevailing around the time of issuance. For example if the bond in question yields 3 percent use the equation 3 0 75 4 percent. In this case for the sake of conservatism we ll assume the yield to worst actually.

You have no debt own your home outright and have built up 500 000 in savings over a long work career. Once set and offered it will remain fixed for the entire tenure. Municipal bonds are one of the safest long term investments. Interest income generated by municipal bonds is generally not subject to federal taxes and may be tax exempt at the state and local level as well if the bonds were issued by the state in which you live.

These securities are sold at a deep discount and pay no annual interest. Divide this into the yield on the tax free bond to find out the tax equivalent yield. Municipal bonds are generally not subject to federal taxes on interest and are often exempt from state and local taxes. Example of calculating after tax bond income.

Corporate bonds have no tax free provisions. If you plug different tax rates into the equation above you will see that the higher your tax rate the higher the tax equivalent yield illustrating how tax free. Imagine that you are 65 years old. As the name suggests interest earned from tax free bonds is exempt from tax.

Municipal bond income is exempt from federal and state income taxes. But in early 2008 something happened that s only occurred in the u s. Municipal bonds work best for investors who need a tax free revenue stream. Learn about tax free bonds.

While municipal bonds are available in both taxable and tax exempt formats the tax exempt bonds tend to get the most attention because the income they generate is for. How municipal bonds work. Even someone paying 20 6 per cent tax may find these tax free bonds suitable. Tax free bonds are a fixed income instrument carrying a coupon rate of interest and is issued for a fixed tenure.

What are they how they work and how to choose the best tax free bonds. The full face value is paid at maturity. Because they re so secure they usually carry interest rates that average a percentage point or two below the going rate for treasury bills. As a result they have slightly lower interest rates than taxable bonds.