5 Things to Consider About Taxable Municipal Bonds

Taxable municipal bonds may be an attractive option for investors in lower tax brackets, but there are things investors should know before making a decision.

There's a small portion of the bond market that investors may have overlooked but now may want to 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.

Below are some of the primary reasons we think investors should consider taxable munis. But first, a quick introduction to taxable municipal bonds:

A primer on taxable munis

The main difference between a taxable municipal bond and a tax-exempt muni is that taxable munis pay interest income that's subject to federal and state income taxes, whereas tax-exempt munis pay interest income that's generally exempt from federal and state income taxes. They're often issued by the same issuer and therefore don't differ in credit quality. For example, issuers like the State of California, the New Jersey Turnpike Authority and the University of Michigan, just to name a few, all issue both taxable and tax-exempt munis. An issuer may choose to issue a bond as either a taxable or tax-exempt issue for a variety of reasons, such as the yield environment or to attract a different investor base to increase demand for their bonds.

Due to the different tax treatments between taxable and tax-exempt munis, we believe that taxable municipal bonds may be an attractive option for investors in lower tax brackets or for tax-advantaged accounts like an individual retirement account (IRA). Investors in higher tax brackets may still want to consider tax-exempt munis, as they may yield more than taxable munis after considering the effects of taxes.

Investors in lower tax brackets may want to consider taxable munis vs. tax-exempt munis