If you’re interested in municipal bonds, the first step is to determine whether you should buy taxable or tax-exempt bonds for the fixed-income portion of your portfolio. Generally, the higher your tax bracket, the more appropriate an investment in tax-exempt municipal bonds will be.
While you might earn 5% from a Treasury bond, you would take home only 3.5%, aftertax, assuming a 30% tax bracket in 2002. In that case, you would receive greater after-tax income from a municipal bond yielding 4%. If you decide on municipal bonds, you can buy bonds issued locally or out-of-state. If you buy an out-of-state bond, you may owe state income taxes.
For example, Pennsylvania levies a 2.8% income tax; some localities have income taxes, too. If you live in Pennsylvania and buy a bond issued in some other state, you’d owe state income tax on the interest income from that bond; a locally-issued bond, though, may be totally tax-free. When buying individual bonds, be cognizant that the longer the time to maturity, the higher the commission to the broker selling the bond. The same may be true for credit ratings: typically the lower the quality of the bond, the higher the commission to the selling broker.
