Why Investors Should Consider Taxable Municipal Bonds

There’s a small portion of the bond market that investors may have overlooked in the past, but should now consider—the taxable municipal bond market.

Most munis pay interest that is exempt from federal and potentially state income taxes. However, interest on some municipal bonds is subject to both federal and state income taxes. These bonds, known as taxable municipal bonds, generally pay higher interest rates than tax-exempt munis to make up for the lack of tax benefits.

Today, taxable municipal bonds look attractive to us because they offer higher yields without having to take on too much additional credit risk. Issuance of taxable munis also has increased—meaning more selection, which is helpful for diversification. Below are some of the primary reasons we think investors should consider taxable munis.

1. Taxable munis offer attractive yields relative to other fixed income investments.

Yields for taxable municipal bonds are attractive, in our view, relative to many other fixed income investments. As illustrated in the chart below, even after adjusting for taxes, taxable munis offer higher yields compared to tax-exempt munis for taxpayers in the 32% and below brackets. They also yield more than corporate and Treasury bonds at all tax brackets. It’s important to note that these yields are based on indices, and there may be differences when comparing individual bonds.

After-tax yield comparisons for different bonds at various tax brackets

Source: Bloomberg Barclays US Municipal Bond Index, Bloomberg Barclays US Taxable Municipal Bond Index, Bloomberg Barclays US Corporate Bond Index, and Bloomberg Barclays US Treasury Bond Index, as of 7/28/2020. Corporates and taxable munis assume an additional 5% state income tax and 3.8% ACA tax for the 32% and above brackets. Treasuries assume a 3.8% ACA tax for the 32% and above brackets. Difference in yields may be due to index characteristics such as duration, maturity, or credit quality. After-tax YTW (yield to worst) is the lowest potential yield you may receive from a bond, assuming the issuer does not default. Past performance is no guarantee of future results.